##### **SECURITIES AND EXCHANGECOMMISSION**

###### **WASHINGTON, DC 20549**

** **

----

** **

**FORM10-Q**

 **(Mark One)**

 

**ý****        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES**

**            EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2001**

 

**OR**

 

**o****        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**            SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from___________ to ____________**

 

 

**Commission File No. 000-23221**

 

 

**TEKGRAF,INC.**

(Exactname of Registrant as specified in its charter)

 

 

|                                 |   |                      |
|--------------------------------------|--------|---------------------------|
| **Georgia**                          |   | **58-2033795**            |
| *(State  or other jurisdiction*      |   | *(IRS  Employer*          |
| *of  incorporation or organization)* |   | *Identification  Number)* |
|                                 |   |                      |

 

** **

**980 Corporate WoodsParkway, Vernon Hills, Illinois  60061**

** **

**(Address of PrincipalExecutive Offices, including Zip Code)**

 

 

**(847) 913-5888**

(Registrant’stelephone number, including area code)

 

 

 

                Indicateby check mark whether the registrant: (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes:ý No: o

 

 

                Thenumber of shares outstanding of the Registrant’s common stock, par value$.001,  as of November 11, 2001, thelatest practicable date, was 4,956,535 shares.

 

 

**TEKGRAF, INC.**

##### **TABLE OF CONTENTS**

 
| **ITEM**                                |                                                                                                           |   |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------|--------|
| **PART  I  FINANCIAL INFORMATION** |                                                                                                           |
|                                    |                                                                                                           |   |
| Item  1.                                | Consolidated  Financial Statements (unaudited):                                                                |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated Balance  Sheets as of September 30, 2001 and December 31, 2000                                    |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated  Statements of Operations for the three months and nine months ended September  30, 2001 and 2000 |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2001 and  2000                  |   |
|                                    |                                                                                                           |   |
|                                    | Notes to  Consolidated 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                                                    |   |
|                                    |                                                                                                           |   |
| **PART  II  OTHER INFORMATION**    |                                                                                                           |
|                                    |                                                                                                           |   |
| Item 2.                                 | Changes in Securities and Use of Proceeds                                                                      |   |
|                                    |                                                                                                           |   |
| Item 6.                                 | Exhibits  and Reports on Form 8-K                                                                              |   |
|                                    |                                                                                                           |   |
| Signatures                              |                                                                                                           |
|                                    |                                                                                                           |   |
| Index of  Exhibits                      |                                                                                                           |

######  

###### **PART I – FINANCIAL INFORMATION**

 

TEKGRAF, INC.

 

CONSOLIDATEDBALANCE SHEETS

($ in thousands)
|                                                                                                                                                      |             | **September 30,**

**2001**

**(unaudited)** |           |   |           |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------------|----------------------------------------------|----------------|--------|----------------|
|                                                                                                                                                      | **December 31,** |                                         |
|                                                                                                                                                      | **2000**         |                                         |
| ASSETS                                                                                                                                                    |             |                                         | ** **     |   | ** **     |
| Current assets:                                                                                                                                           |             |                                         |           |   |           |
| Cash and cash equivalents                                                                                                                                 |             | $                                            | 325            |   | $              | 491 |   |
| Accounts receivable, less allowance for doubtful  accounts of $398 and $512 at September 30, 2001 and December 31, 2000,  respectively                    |             | 8,163                                        |      | 17,882 |      |
| Inventories, net                                                                                                                                          |             | 7,316                                        |           | 9,681  |           |
| Prepaid expenses and other assets                                                                                                                         |             | 490                                          |           | 431    |           |
| Income taxes receivable                                                                                                                                   |             | 72                                           |           | 71     |           |
| Total current assets                                                                                                                                      |             | 16,366                                       |           | 28,556 |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Property and equipment, net                                                                                                                               |             | 3,490                                        |           | 2,822  |           |
| Goodwill, net                                                                                                                                             |             | 1,989                                        |           | 2,128  |           |
| Deferred income taxes                                                                                                                                     |             | 2,318                                        |           | 1,673  |           |
| Other assets                                                                                                                                              |             | 99                                           |           | 91     |           |
| Total assets                                                                                                                                              |             | $                                            | 24,262         |   | $              | 35,270 |   |
|                                                                                                                                                      |             |                                         |           |   |           |
| LIABILITIES                                                                                                                                               |             |                                         |           |   |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Current liabilities:                                                                                                                                      |             |                                         |           |   |           |
| Current debt                                                                                                                                              |             | $                                            | 7,404          |   | $              | 11,142 |   |
| Current note payable                                                                                                                                      |             | 263                                          |           | 1,705  |           |
| Accounts payable                                                                                                                                          |             | 5,516                                        |           | 10,274 |           |
| Accrued expenses                                                                                                                                          |             | 2,723                                        |           | 2,072  |           |
| Contract obligation and deferred income                                                                                                                   |             | 2,200                                        |           | 2,238  |           |
| Total current liabilities                                                                                                                                 |             | 18,106                                       |           | 27,431 |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Total liabilities                                                                                                                                         |             | 18,106                                       |           | 27,431 |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Commitments and contingencies                                                                                                                             |             | 0                                            |           | 0      |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| STOCKHOLDERS'  EQUITY                                                                                                                                     |             |                                         |           |   |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Class A Common Stock $.001 par value, 35,000,000  shares authorized; 4,956,535 shares issued and outstanding at September 30,  2001 and December 31, 2000 |             | 5                                            |           | 5      |           |
| Preferred Stock, $.001 par value, 5,000,000 shares  authorized; no shares issued and outstanding at September 30, 2001 and  December 31, 2000             |             | 0                                            |           | 0      |           |
| Due from stockholder                                                                                                                                      |             | (2,074                                       | )              | (1,941 | )              |
| Additional paid-in capital                                                                                                                                |             | 19,521                                       |           | 19,521 |           |
| Accumulated deficit                                                                                                                                       |             | (11,296                                      | )              | (9,746 | )              |
|                                                                                                                                                      |             |                                         |           |   |           |
| Total stockholders' equity                                                                                                                                |             | 6,156                                        |           | 7,839  |           |
|                                                                                                                                                      |             |                                         |           |   |           |
| Total liabilities and stockholders' equity                                                                                                                |             | $                                            | 24,262         |   | $              | 35,270 |   |

 

 

The accompanyingnotes are an integral part of these consolidated financial statements.

TEKGRAF, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

($ in thousands, except per share amounts)

 
|                                                              |   | **Three months ended** |   | **Three months ended**  |   | **Nine months ended**  |   | **Nine months ended**   |   |
|-------------------------------------------------------------------|--------|------------------------|--------|-------------------------|--------|------------------------|--------|-------------------------|--------|
|                                                              |   | **September 30, 2001** |   | **September 30, 2000*** |   | **September 30, 2001** |   | **September 30, 2000*** |   |
|                                                              |   | **(unaudited)**        |   | **(unaudited)**         |   | **(unaudited)**        |   | **(unaudited)**         |   |
| Net sales                                                         |   | $                      | 16,566 |                    | $      | 21,376                 |   | $                       | 54,098 |   | $ | 66,910 |   |
| Cost of goods sold                                                |   | 13,777                 |   | 18,598                  |   | 45,194                 |   | 57,060                  |   |
| Gross profit                                                      |   | 2,789                  |   | 2,778                   |   | 8,904                  |   | 9,850                   |   |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Operating expenses:                                               |   |                   |   |                    |   |                   |   |                    |   |
| Selling, general and administrative                               |   | 3,448                  |   | 3,515                   |   | 9,612                  |   | 11,161                  |   |
| Depreciation                                                      |   | 242                    |   | 132                     |   | 572                    |   | 357                     |   |
| Amortization of goodwill                                          |   | 47                     |   | 45                      |   | 140                    |   | 140                     |   |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Loss from continuing operations before interest and  income taxes |   | (948                   | )      | (914                    | )      | (1,420                 | )      | (1,808                  | )      |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Interest expense, net                                             |   | 351                    |   | 55                      |   | 775                    |   | 174                     |   |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Loss before benefit for income taxes                              |   | (1,299                 | )      | (969                    | )      | (2,195                 | )      | (1,982                  | )      |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Benefit for income taxes                                          |   | (360                   | )      | (342                    | )      | (645                   | )      | (664                    | )      |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Loss from continuing operations                                   |   | (939                   | )      | (627                    | )      | (1,550                 | )      | (1,318                  | )      |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Loss from discontinued operations (net of tax benefit)            |   | 0                      |   | (44                     | )      | 0                      |   | (85                     | )      |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Net loss                                                          |   | $                      | (939   | )                       | $      | (671                   | )      | $                       | (1,550 | ) | $ | (1,403 | ) |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Basic and diluted weighted average shares outstanding             |   | 4,956,535              |   | 6,161,664               |   | 4,982,618              |   | 6,161,664               |   |
|                                                              |   |                   |   |                    |   |                   |   |                    |   |
| Loss applicable to common shares:                                 |   |                   |   |                    |   |                   |   |                    |   |
| Continuing operations                                             |   | $                      | (0.19  | )                       | $      | (0.10                  | )      | $                       | (0.31  | ) | $ | (0.21 | ) |
| Discontinued operations                                           |   | $                      | (0.00  | )                       | $      | (0.01                  | )      | $                       | (0.00  | ) | $ | (0.02 | ) |
| Net loss                                                          |   | $                      | (0.19  | )                       | $      | (0.11                  | )      | $                       | (0.31  | ) | $ | (0.23 | ) |

 

----

*As reclassified for discontinued operations.

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

 

TEKGRAF,INC.

 

CONSOLIDATED STATEMENTSOF CASH FLOWS

 

($in thousands)
|                                                         |   |                   |       |                   |       |
|--------------------------------------------------------------|--------|------------------------|------------|------------------------|------------|
|                                                         |   | **Nine months ended**  |       | **Nine months ended**  |       |
|                                                         |   | **September 30, 2001** |       | **September 30, 2000** |       |
|                                                         |   | **(unaudited)**        |       | **(unaudited)**        | ** ** |
| **Cash flows from operating activities:**                    |   |                   | ** ** |                   | ** ** |
| Net  loss                                                    |   | $                      | (1,550     | )                      | $          | (1,403 | ) |
| Adjustments  to reconcile net loss to                        |   |                   |       |                   |       |
| Cash  provided by (used in) operating activities:            |   |                   |       |                   |       |
| Provision  for doubtful accounts receivable                  |   | 408                    |       | 302                    |       |
| Provision  /write-down of inventory                          |   | 25                     |       | 225                    |       |
| Imputed  interest on note payable                            |   | 62                     |       | 0                      |       |
| Depreciation                                                 |   | 572                    |       | 359                    |       |
| Amortization  and impairment of goodwill                     |   | 139                    |       | 140                    |       |
| Deferred  taxes                                              |   | (645                   | )          | (716                   | )          |
| Non-cash  compensation for warrants and stock options        |   | 0                      |       | 100                    |       |
| Changes  in net assets and liabilities, net of acquisitions: |   |                   |       |                   |       |
| Accounts  receivable                                         |   | 9,311                  |       | 2,204                  |       |
| Inventories                                                  |   | 2,340                  |       | 3,761                  |       |
| Prepaid  expenses and other assets                           |   | (67                    | )          | 60                     |       |
| Accounts  payable and accrued expenses                       |   | (4,107                 | )          | (6,212                 | )          |
| Deferred  income and contract obligation                     |   | (38                    | )          | (983                   | )          |
| Income  taxes                                                |   | (1                     | )          | (49                    | )          |
| Total  adjustments                                           |   | 7,999                  |       | (809                   | )          |
| **Cash provided by (used in) operating activities**          |   | 6,449                  |       | (2,212                 | )          |
|                                                         |   |                   |       |                   |       |
| **Cash flows from investing activities:**                    |   |                   |       |                   |       |
| Purchase  of property and equipment                          |   | (1,240                 | )          | (737                   | )          |
| **Cash used in investing activities**                        |   | (1,240                 | )          | (737                   | )          |
|                                                         |   |                   |       |                   |       |
| **Cash flows from financing activities:**                    |   |                   |       |                   |       |
| Proceeds/(repayment)  from debt, net                         |   | (3,738                 | )          | 2,267                  |       |
| Loan  to stockholder                                         |   | (133                   | )          | 5                      |       |
| Payments  for Dissenters’ settlement                    |   | (1,504                 | )          | 0                      |       |
| **Cash provided by (used in) financing activities**          |   | (5,375                 | )          | 2,272                  |       |
|                                                         |   |                   |       |                   |       |
| Decrease  in cash and cash equivalents                       |   | (166                   | )          | (677                   | )          |
| Cash  and cash equivalents, beginning of year                |   | 491                    |       | 1,704                  |       |
| Cash  and cash equivalents, end of period                    |   | $                      | 325        |                   | $          | 1,027 |   |
|                                                         |   |                   |       |                   |       |

 

The accompanying notes are an integralpart of these consolidated financial statements.

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.   BASIS OFPRESENTATION**

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith generally accepted accounting principles for interim financial informationand with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from those estimates.  In the opinion of management, alladjustments considered necessary for a fair presentation have beenincluded.  Operating results for thethree months ended September 30, 2001 and the nine months ended September 30,2001 are not necessarily indicative of the results that may be expected for thefull year ending December 31, 2001.  Forfurther information, refer to the consolidated financial statements and thefootnotes included in the Form 10-K for the year ended December 31, 2000.

 

**2.  ****INVENTORIES**

 

Inventories, net ofreserves, at September 30, 2001 and December 31, 2000 consist of the following:

 

|              |   | **September 30,**     |   | **December 31,**      |   |
|-------------------|--------|-----------------------|--------|-----------------------|--------|
|              |   | **2001**              |   | **2000**              |   |
|              |   | **($ in  thousands)** |   | **($ in  thousands)** |   |
|              |   | **(unaudited)**       |   |                  |   |
| Service  parts    |   | $                     | 1,992  |                  | $      | 1,970 |   |
| Finished  goods   |   | 5,324                 |   | 7,711                 |   |
|              |   |                  |   |                  |   |
| Inventories,  net |   | $                     | 7,316  |                  | $      | 9,681 |   |

 

**3.****   NET LOSS PER COMMON SHARE**

 

Basic and diluted netloss per common share are computed by dividing net loss by the weighted averagenumber of common shares and common share equivalents outstanding during theperiod.  There were no common shareequivalents that were dilutive during any of the periods presented.  At September 30, 2001, the basic and dilutedweighted average shares were as follows:

 
| Basic and diluted  weighted average shares | 4,956,535 |   |
|--------------------------------------------|-----------|--------|

 

**4.****   INCOME TAXES**

 

TheCompany’s effective tax rate was a benefit of 27.5% and 35.3% for the threemonths ended September 30, 2001 and 2000, respectively.  The Company’s effective tax rate was abenefit of 29.4 % and 33.5% for the nine months ended September 30, 2001 and2000, respectively.  The differencebetween the Company’s effective and statutory tax rates for those periods wasprimarily due to the amortization of non-deductible goodwill and state taxes,net of the federal benefit.

**5.     CURRENT DEBT**

** **

TheCompany was out of compliance with certain covenants under its bank agreement,including the fixed charge coverage and leverage ratios, for the months endedAugust 31, September 30 and October 31, 2001 and has obtained a waiver from thebank.  In connection with the waiver,the Company has agreed that the financial covenants contained in the bank agreementwill continue to be tested on a monthly basis.

 

**TheCompany believes that its available funds together with its current andanticipated credit facilities will be adequate to satisfy its current andplanned operations, including restructuring accruals, for at least the next 12months.**

** **

**6.****   ESCROW SHARES**

** **

**The number of outstanding shares does not include228,266 shares held in escrow in connection with an acquisition by the Companypursuant to a Pledge, Security and Escrow Agreement dated June 2, 1997.  All of the interest in and title to these228,266 shares was transferred to Anita Ltd. and then subsequently transferredto the Company as part of a Settlement Agreement and Mutual Releases dated asof December 21, 2000.  These shares willultimately be released from the escrow to the Company and will becancelled.  Therefore, the Company has,for accounting purposes, treated these shares as cancelled effective as ofDecember 21, 2000.**

** **

**7.****   PATENT APPLICATION**

** **

On March 21, 2001, theCompany filed a patent application with the United States Patent and TrademarkOffice relating to a sign creation and delivery management system for creatingpoint of purchase signage.  The CentivBusiness will market and sell this system, which allows a user access to aninformation database for selecting sign templates, inputting data for the signtemplates and selecting signage products for production of the signtemplates.  The user can then order thecreated sign templates having data input and selected signage products fordelivery to the user.

** **

**8.   IMPAIRMENT OF GOODWILL AND RESTRUCTURINGCHARGES AND OTHER EXPENSES**

** **

Managementof the Company has continually reviewed the recoverability of the goodwillrecorded in connection with the Company’s acquisitions, as events and changesin circumstances have warranted, to determine whether or not any of thegoodwill associated with the acquisitions has been impaired.

 

Thefollowing table provides a roll forward of the liabilities incurred inconnection with the 2000 and 2001 business restructuring.

**($ in thousands)**

** **
|                 |   | **December  31, 2000** |   | **Three  months ended September 30, 2001** |   | **Nine  months ended September 30, 2001** |   | **September  30, 2001** |   |
|----------------------|--------|------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|-------------------------|--------|
| **Type of Cost**     |   | **Balance**            |   | **Activity**                               |   | **Activity**                              |   | **Balance**             |   |
| Employee Separations |   | $                      | 157    |                                       | $      | (30                                       | )      | $                       | (117   | ) | $ | 40 |   |
|                 |   |                   |   |                                       |   |                                      |   |                    |   |
| Facility Closings    |   | 399                    |   | (95                                        | )      | (289                                      | )      | 110                     |   |
| Total                |   | $                      | 556    |                                       | $      | (125                                      | )      | $                       | (406   | ) | $ | 150 |   |

 

For the three months and nine months ended September30, 2001, restructuring reserve balances were reduced by $125,000 and $406,000,respectively.  Employee separations of$30,000 and $117,000 were charged against the restructuring reserve for thethree months and nine months ended September 30, 2001, respectively.   Facility closings of $95,000 and $289,000were charged against the restructuring reserve for the three months and ninemonths ended September 30, 2001, respectively.   The restructuring reserve balance is $150,000 as of September30, 2001.

 

**9.  ****SEGMENT DISCLOSURES**

 

Duringthe year ended December 31, 2000, the Company reevaluated its current segmentreporting.  In previous years, theCompany had three business units: Graphics, Technology and Services. The Company’s management now segments the business into three businessunits:  Channels, Centiv (POP) andServices.  All prior year results havebeen restated to be comparative to the current year’s results.  These business units are revenue producingcomponents of the Company about which separate financial information isproduced internally and operating decisions are made.  For the Channels Business net sales, no one customer accountedfor more than 10% of the sales for the three months or nine months endedSeptember 30, 2001 and September 30, 2000. For the Centiv Business net sales, one customer accounted for 92% and97% of the sales for the three months and nine months ended September 30, 2001and September 30, 2000, respectively. No customers accounted for more than 10% of net sales for the ServicesBusiness for three months and six months ended September 30, 2001, or the threemonths and nine months ended September 30, 2000.  International sales for all three business units wereinsignificant for the three months and nine months ended September 30, 2001 andthe three months and nine months ended September 30, 2000.  The following segment information is for thethree months and nine months ended September 30, 2001 and 2000:

 

** **
|                                                                   |   | **Three months ended** |   | **Nine months ended**  |   |
|------------------------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                                                   |   | **September 30, 2001** |   | **September 30, 2000** |   | **September 30, 2001** |   | **September 30, 2000** |   |
|                                                                   |   |                   |   | ***As Restated**       |   |   |   | ***As Restated** |   |
|                                                                   |   | **($ in  thousands)**  |   | **($ in  thousands)**  |   | **($ in  thousands)** |   | **($ in  thousands)** |   |
| Net sales:                                                             |   |                   |   |                   |   |   |   |   |   |
| Channels                                                               |   | $                      | 11,545 |                   | $      | 17,409 |   | $ | 39,551 |   | $ | 52,908 |   |
| Centiv  (POP)                                                          |   | 3,222                  |   | 2,175                  |   | 9,156 |   | 7,870 |   |
| Services                                                               |   | 2,032                  |   | 2,082                  |   | 6,297 |   | 6,827 |   |
| Eliminations                                                           |   | (233                   | )      | (290                   | )      | (906 | ) | (695 | ) |
| Total  net sales                                                       |   | $                      | 16,566 |                   | $      | 21,376 |   | $ | 54,098 |   | $ | 66,910 |   |
|                                                                   |   |                   |   |                   |   |   |   |   |   |
| Net  sales from discontinued operations                                |   | $                      | 0      |                   | $      | 1,770 |   | $ | 0 |   | $ | 5,972 |   |
|                                                                   |   |                   |   |                   |   |   |   |   |   |
| Operating  income (loss) from continuing operations:                   |   |                   |   |                   |   |   |   |   |   |
| Channels                                                               |   | $                      | (521   | )                      | $      | (822 | ) | $ | (205 | ) | $ | (1,823 | ) |
| Centiv  (POP)                                                          |   | (498                   | )      | (170                   | )      | (1,431 | ) | (645 | ) |
| Services                                                               |   | 62                     |   | 78                     |   | 216 |   | 660 |   |
| Net  loss from continuing operations before interest and income taxes  |   | $                      | (957   | )                      | $      | (914 | ) | $ | (1,420 | ) | $ | (1,808 | ) |
|                                                                   |   |                   |   |                   |   |   |   |   |   |
| Total  operating income (loss) for discontinued operations, net of tax |   | $                      | 0      |                   | $      | (44 | ) | $ | 0 |   | $ | (85 | ) |
|                                                                   |   |                   |   |                   |   |   |   |   |   |
| Identifiable  assets:                                                  |   |                   |   |                   |   |   |   |   |   |
| Channels                                                               |   | $                      | 17,004 |                   | $      | 24,207 |   | $ | 17,004 |   | $ | 24,207 |   |
| Centiv  (POP)                                                          |   | 2,934                  |   | 2,818                  |   | 2,934 |   | 2,818 |   |
| Services                                                               |   | 4,324                  |   | 4,039                  |   | 4,324 |   | 4,039 |   |
|                                                                   |   |                   |   |                   |   |   |   |   |   |
| Total  identifiable assets                                             |   | $                      | 24,262 |                   | $      | 31,064 |   | $ | 24,262 |   | $ | 31,064 |   |
|                                                                   |   |                   |   |                   |   |   |   |   |   |

----

*    As restated for discontinued operations

 

**10.  ****RECLASSIFICATIONS**

 

Certainamounts in the September 30, 2000 financial statements have been reclassifiedto conform to the September 30, 2001 presentation.

 

**11.****   DISCONTINUED OPERATIONS – TEKGRAFTECHNOLOGY SERVICES DIVISION**

 

Inresponse to the Company’s reclassification of its Class B Common Stock, whichwas approved by shareholders, certain shareholders exercised dissenters’rights.  As the dissenting shareholdersand the Company could not reach agreement as to the fair value of the shares asof the relevant date, in May 2000, the Company filed a petition in the SuperiorCourt of Fulton County, Georgia for a determination of the fair value of theshares (the “Dissenters’ Lawsuit”).

 

Asof October 31, 2000, the Company sold the assets of its Tekgraf Systemsdivision to Micro Environments, LLC, a limited liability company controlled byAnita, Ltd., one of the dissenting shareholders in the Dissenters’Lawsuit.  As consideration for theassets of the Tekgraf Systems division, Anita, Ltd. transferred to the Company375,752 shares of Class A Common Stock in partial settlement of the Dissenter’sLawsuit.  Tekgraf Systems is anintegrator of desktop PC’s and servers. The division produced  $6.0million in revenue and had an pre-tax operating loss of $(190,000) for the tenmonths ended October 31, 2000.

 

TheCompany’s 2000 consolidated financial statements have been reclassified toreport separately the results of operations for the Tekgraf Technology ServicesDivision.  The operating results (inthousands) for the three months ended and nine months ended September 30, 2000of the discontinued Tekgraf Technology Services Division consist of:

 
|                                      |   | **Three months ended** |   | **Nine months ended** |   |
|-------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                      |   | **September 30,**      |   | **September 30,**     |   |
|                                      |   | **2000**               |   | **2000**              |   |
|                                      |   | **($ in  thousands)**  |   | **($ in  thousands)** |   |
|                                      |   | **(unaudited)**        |   | **(unaudited)**       |   |
| Net sales:                                |   | $                      | 1,770  |                  | $      | 5,972 |   |
|                                      |   |                   |   |                  |   |
| Loss  from operations before income taxes |   | (71                    | )      | (137                  | )      |
| Benefit  from income taxes                |   | 27                     |   | 52                    |   |
|                                      |   |                   |   |                  |   |
| Loss  from discontinued operations        |   | $                      | (44    | )                     | $      | (85 | ) |

 

**12.****   SUBSEQUENT EVENT – DEFINITIVEAGREEMENT TO SELL CHANNELS BUSINESS**

 

On October 29, 2001, the Companyannounced that it had reached a definitive agreement to sell the assets of theCompany’s Channels Business to SCB Acquisitions, LLC of Greenville, SouthCarolina, an investor group that includes an affiliate of the Company, for$7,905,000 in cash, subject to certain post closing adjustments plus theassumption of certain liabilities of the Channels Business Unit.  The sale is expected to be completed byNovember 30, 2001, and is contingent upon lender and Tekgraf shareholderapproval as well as the ability of SCB Acquisitions, LLC to obtain financing onreasonably satisfactory terms and conditions. 

 

 

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

 

The following discussion should be readin conjunction with the information contained in the Consolidated FinancialStatements, including the related notes.

 

### **Overview**

 

In 1997, Tekgraf, Inc.was created from a merger of five wholesale distributors specializing incomputer graphics products and a manufacturer of personal computers andservers.  In 1998, the Company acquiredthree additional wholesale distribution companies and,  in 1999, acquired a field service company.  Tekgraf has integrated the businesses anddistribution systems and has become a leader in the distribution of computergraphics technologies through value-added resellers, system integrators,retailers, mass merchandisers and direct marketers.

 

Utilizing the Company’s expertise in thecomputer graphics market and innovation, Tekgraf expanded its service offeringto provide clients a unique opportunity to increase the visibility of theirproducts at the retail level and make the greatest impact on the consumerthrough digital “Point-of-Purchase” (POP) merchandising.

 

Today, the Company is organized intothree distinct business units:

 

•      Channels Business:  This division specializes in the value-addedwholesale distribution of computer graphics technologies throughout NorthAmerica.  The Company has entered into adefinitive agreement to sell the assets of the Channels Business.  For more information, see Note 12 of “Notesto Consolidated Financial Statements.”

 

•      The Centiv Business:  This division offers digital merchandisingservices utilizing both Internet-based services and turnkey systems to retailand manufacturing customers who wish to produce high-resolution, full colorposters, banners and other custom POP signage.

 

•      CalGraph Technology Services, Inc.:  This wholly owned subsidiary of Tekgraf is aleading provider of on-site service and preventative maintenance servicesspecializing in wide-format printing devices. CalGraph’s U.S. and Canadian service operations include field servicetechnicians, customer support call center, component repair and refurbishmentfacilities and parts logistics.  TheCompany is currently exploring opportunities related to the disposition of theCalgraph Business although no decision has been made or agreement reached atthis time.

 

As of October 31, 2000,the Company sold the assets of its Tekgraf Systems Business to a companycontrolled by a dissenting shareholder.

 

**ThreeMonths Ended September 30, 2001 Compared With Three Months Ended September 30,2000**

 

**ContinuingOperations:**

 

***Net Sales.*** Total net sales from continuing operations decreased $4.8 million, or22.5%, to $16.6 million for the three months ended September 30, 2001, comparedto $21.4 million for the three months ending September 30, 2000.  The decrease in sales was primarily in theChannels Business due to the economic slowdown in the US economy for capitalequipment purchases as well as a significant drop in sales volume in Septemberfollowing the terrorist attacks that occurred on September 11, 2001.  However, the net sales for the CentivBusiness increased 48.1% to $3.2 million for the three months ended September30, 2001, compared to $2.2 million for the three months ended September 30,2000.  This increase is attributable tothe Company’s strategic focus on the development and implementation of Centiv’sInstant Impact, a web-based, online digital merchandizing point-of-purchasesolution for the custom signage business, as well as an increase in productofferings to Centiv’s customer base.

 

***Gross Profit.***  The gross profit as a percentage of salesimproved 3.8% to 16.8% for the three months ended September 30, 2001 from 13.0%for the three months ended September 30, 2000. The margin improvement relates to new higher margin product offerings inboth the Channels and Centiv Businesses. Despite the sales decline, gross profit from continuing operationsremained constant at $2.8 million for the three months ended September 30, 2001and 2000, respectively due to the margin improvement.

 

***SG&A Expenses.***  SG&A expenses fromcontinuing operations decreased $48,000 or 1.4%  to $3.5 million for the three months ended September 30,2001.  SG&A expenses as a percentageof sales were 20.9% and 16.4% for the three months ended September 30, 2001 and2000, respectively.  The SG&Aexpenses for the three months ended September 30, 2001 includes $134,000 ofone-time expense relating to staff reductions. The staff reductions are expected to generate about $850,000 in annualexpense savings.

** **

***Depreciation Expense.  ***Depreciation expense from continuingoperations increased $100,000, or 75.8%, to $232,000 for the three months endedSeptember 30, 2001, as compared to $132,000 for the three months endedSeptember 30, 2000.  The increase isprimarily due to the depreciation expense related to an enterprise widefinancial and operational software package implemented during the secondquarter of 2001.

 

*** ******Amortization of Goodwill.***  Amortization expense from continuingoperations remained relatively constant at $47,000 for the three months endedSeptember 30, 2001 and $45,000 for the three months ended September 30, 2000,respectively.

 

***InterestExpense, net.*** Interest expense from continuing operations increased $296,000 to$351,000 for the three months ended September 30, 2001, as compared to $55,000for the three months ended September 30, 2000. During the third quarter, the Company incurred a $200,000 waiver fee,which is included in the $351,000 for the period ending September 30,2001.  The $200,000 relates to theCompany not meeting certain financial covenants as outlined in the bank agreement.  See Note 5 of “Notes to ConsolidatedFinancial Statements” for further information. The additional $46,000 increase is due to the increase in the Company’snet debt from  $6.5 million as ofSeptember 30, 2000 to $7.4 million as of September 30, 2001.  However, the Company’s net debt, which isthe Company’s bank debt and notes payable, minus cash,  has decreased $5.1 million or 41.1%, from$12.4 million as of December 31, 2000 to $7.3 million as of September 30, 2001.

 

***Income Taxes.***  The Company’s effective tax rate forcontinuing operations was a benefit of 27.5% for the three months endedSeptember 30, 2001 compared to a benefit of 35.3% for the three months endedSeptember 30, 2000.

 

***Net Loss.***  The Company’s net loss from continuingoperations was $0.9 million for the three months ended September 30, 2001 ascompared to a loss of $0.7 for the three months ended September 30, 2000.  The increase in net loss is due primarily tothe $200,000 bank waiver fee and the increase in depreciation expense asdiscussed above.

 

**DiscontinuedOperations:**

 

The Company had a net after tax loss fromdiscontinued operations of $44,000 for the three months ended September 30,2000 relating to the Tekgraf Technology Systems Business.

 

**NineMonths Ended September 30, 2001 Compared With Nine Months Ended September 30,2000**

 

**ContinuingOperations:**

 

***Net Sales.*** Total net sales from continuing operations decreased $12.8 million, or19.1%, to $54.1 million for the nine months ended September 30, 2001, comparedto $66.9 million for the nine months ending September 30, 2000.  The decrease in sales was primarily in theChannels Business due to the economic slowdown in the US economy for capitalequipment purchases as well as a strategic emphasis on selling higher marginproducts into the sales channel. However, the net sales for the Centiv Business increased 16.3% to $9.2million for the nine months ended September 30, 2001, compared to $7.9 millionfor the nine months ended September 30, 2000. This increase is attributable to the Company’s strategic focus on the developmentand implementation of Centiv’s Instant Impact, a web-based, online digitalmerchandizing point-of-purchase solution for the custom signage business, aswell as an increase in product offerings to Centiv’s customer base.

 

***Gross Profit.***  The gross profit as a percentage of salesimproved 1.7% to 16.4% for the nine months ended September 30, 2001 from 14.7%for the nine months ended September 30, 2000. The margin improvement relates to new higher margin product offerings inboth the Channels and Centiv Businesses. Gross profit from continuing operations decreased $1.0 million or 9.7%to $8.9 million for the nine months ended September 30, 2001 as compared to$9.0 million for the nine months ended September 30, 2000.

 

***SG&A Expenses.***  SG&A expenses fromcontinuing operations decreased $1.6 million or 13.9% to $9.6 million for thenine months ended September 30, 2001 compared to $11.2 million for the ninemonths ended September 30, 2000. SG&A expenses as a percentage of sales were 17.8% and 16.7% for thenine months ended September 30, 2001 and 2000, respectively.   The decrease in SG&A expenses relatesto the cost-cutting measures the Company implemented during the fourth quarterof 2000 to reduce overhead expenses.  Inaddition, the prior year contained one-time unusual expenses associated withthe settlement of legal disputes associated with the dissenting shareholder’sclaim, relocation of the Company’s headquarters and the establishment of a newmanagement team.  The SG&A expensesfor the nine months ended September 30, 2001 includes $134,000 of one-timeexpense for staff reductions.  The staffreductions are expected to generate about $850,000 in annual expense savings.

** **

***Depreciation Expense.  ***Depreciation expense from continuingoperations increased $215,000 or 60.2%, to $572,000 for the nine months endedSeptember 30, 2001, as compared to $357,000 for the nine months ended September30, 2000.  The increase relates to theCompany implementing a new state of the art enterprise wide software package aswell as web development of the Centiv Business’ new online digitalmerchandizing point-of-purchase for the custom signage business.

 

*** ******Amortization of Goodwill.***  Amortization expense from continuingoperations remained constant at $140,000 for the nine months ended September30, 2001 and September 30, 2000, respectively.

 

***InterestExpense, net.*** Interest expense from continuing operations increased $601,000 to$775,000 for the nine months ended September 30, 2001, as compared to $174,000for the nine months ended September 30, 2000. During the third quarter, the Company incurred a $200,000 waiver fee,which is included in the $775,000 for the period ending September 30,2001.  The $200,000 relates to theCompany not meeting certain financial covenants as outlined in the bankagreement.  See Note 5 of “Notes toConsolidated Financial Statements” for further information.  The Company’s net debt, which is theCompany’s bank debt and notes payable, minus cash,  has decreased $5.1 million or 41.1%, from $12.4 million as ofDecember 31, 2000 to $7.3 million as of September 30, 2001.

 

***Income Taxes.***  The Company’s effective tax rate forcontinuing operations was a benefit of 29.4% for the nine months endedSeptember 30, 2001, compared to a benefit of 33.5% for the nine months endedSeptember 30, 2000.

 

***Net Loss.***  The Company had a net loss from continuingoperations of $1.6 million for the nine months ended September 30, 2001, ascompared to a net loss of $1.3 million for the nine months ended September 30,2000.

 

**DiscontinuedOperations:**

 

The Company had a net after tax loss fromdiscontinued operations of $85,000 for the nine months ended September 30, 2000relating to the Tekgraf Technology Systems Business.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company generated $6.4 million ofcash from operations for the nine months ended September 30, 2001 compared tocash used of $2.2 million from operations for the nine months ended September30, 2000.  During the nine months endedSeptember 30, 2001, accounts receivable generated $9.3 million, inventorygenerated $2.3 million and accounts payable used $4.1 million.  Cash generated from accounts receivables wasa result of improvement in the collection period as well as lower sales in theperiod.  Cash generated from inventorywas due to management’s focus on reducing inventory levels.  The use of cash for accounts payable was forthe payment to vendors relating to inventory purchases associated with thestrong fourth quarter 2000 sales.

 

On September 30, 2001, the Company had anegative working capital of $1.7 million, compared to a positive  $1.1 million as of December 31, 2000.

 

For the nine months ended September 30,2001 and September 30, 2000, the Company used $1.2 million and $0.7 million ofcash, respectively, in investing activities due to the purchase of property andequipment.  The cash used for the ninemonths ended September 30, 2001 relates to the Company implementing a new stateof the art enterprise wide software package as well as development costsrelated to the Centiv Business’ new on-line digital merchandizing systems forpoint-of-purchase customized signage.

 

For the nine months ended September 30,2001, the Company used $5.4 million in financing activities to pay down thebank line of $3.7 million and pay to down $1.5 million on the note issued inconnection with the settlement of the Dissenters’ Lawsuit (see Note 11 of Notesto Consolidated Financial Statements).  During the nine months ended September 30, 2001, the Company hadborrowings of $49.6 million and repayments of $53.3 million under theoutstanding bank loan.

 

The Company was out ofcompliance with certain covenants under its bank agreement, including the fixedcharge coverage and leverage ratios, for the months ended August 31, September30, and October 31, 2001 has obtained a waiver from the bank.  In connection with the waiver, the Companyhas agreed that the financial covenants contained in the bank agreement willcontinue to be tested on a monthly basis.

** **

**To complete the contemplated saleof the assets of the Channels Business, the Company must obtain the consent ofthe bank under its credit agreement and the release of outstanding securityinterests held by the bank in assets of the Channels Business.  The bank has consented to the sale and hasagreed to release the security interests, subject to the Company’s repayment ofa substantial portion of its indebtedness owing to the bank on the closing ofthe sale, the Company maintaining a $400,000 borrowing base availability untilthe consummation of the sale, and the amendment and restatement of theCompany’s outstanding credit facility subsequent to the consummation of thesale.  After the sale of the ChannelsBusiness assets, the borrowing base under the Company’s credit agreement willbe reduced accordingly.**

** **

**The Company believes that itsavailable funds together with its current and anticipated credit facilitieswill be adequate to satisfy its current and planned operations, includingrestructuring accruals, for at least the next 12  months.**

 

On June 29, 2001, the FinancialAccounting Standards Board (FASB) approved for issuance Statement of AccountingStandards No. 142, *Goodwill and OtherIntangible Assets*.  The FASBissued these Statements on July 20, 2001. Major provisions of this Statement include the following:

 

•      anynegative goodwill remaining after reducing the carrying value of certainacquired assets to zero is recognized as an extraordinary gain

 

•      goodwilland those intangible assets that have indefinite lives are not amortized but aretested for impairment annually and whenever there is an impairmentindicator.  In certain circumstances,goodwill impairment testing need not be done annually.  All acquired goodwill must be assigned toreporting units for purposes of impairment testing.

 

•      SFAS 142 iseffective for fiscal years beginning after December 15, 2001.  Early adoption is permitted for companieswith fiscal years beginning after March 15, 2001 but only if they have notissued their first quarter financial statements prior to adoption. Regardlessof the full adoption date, the nonamortization provisions of SFAS 142 areeffective for business combinations and other transactions completed after June30, 2001.

 

•      theStatement also includes guidance on financial statement presentation anddisclosures.

 

The Company will implement FAS 142 as of January 1, 2002.

 

### **DISCLOSURE REGARDINGFORWARD-LOOKING STATEMENTS**

 

“Management’sDiscussion and Analysis of Financial Condition and Results of Operations”,“Notes of Consolidated Financial Statements” and other sections of this reportcontain “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended.  Thesestatements appear in a number of places in this report and include allstatements that are not historical facts. Some of the forward-looking statements relate to the intent, belief orexpectations of the Company and its management regarding the Company’sstrategies and plans for operations and growth.  Other forward-looking statements relate to trends affecting theCompany’s financial condition and results of operations, and the Company’santicipated capital needs and expenditures.

 

Investors are cautioned that suchforward-looking statements are not guarantees of future performance and involverisks and uncertainties, and that actual results may differ materially fromthose that are anticipated in the forward-looking statements as a result of theimpact of events following from the September 11, 2001 terrorist attacks, theimpact of competition and competitive pricing, business conditions and growthin the industry, general and economic conditions, and other risks.  Investors should review the more detaileddescription of these and other possible risks contained in the Company’sfilings with the Securities and Exchange Commission, including the Company’sForm 10-K.  Unless otherwise required byapplicable securities laws, the Company disclaims any intention or obligationto update or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise.

**ITEM 3.****  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISKS**

 

Financial instruments that potentiallysubject the Company to significant concentrations of credit risk consistprincipally of trade accounts receivable. Credit risks with respect to trade receivables are limited due to thediversity of customers comprising the Company’s customer base.  The Company purchases credit insurance forall significant open accounts and the Company performs ongoing creditevaluations and charges uncollectible amounts to operations when they aredetermined to be uncollectible.

###### ** **

###### ** **

###### **PART II –  OTHER INFORMATION**

 

Item2.     Changes in Securities and Use of Proceeds

 

TheCompany will issue 30,000 shares of common stock if the Company’s stock priceis $1.50 for 10 consecutive business days and warrants the purchase of up to60,000 shares of common stock to Piedmont Consulting, Inc. (“Piedmont”) underthe terms of a Consulting Agreement dated as of July 3, 2001. The warrantsare exercisable at $1.15 per share and expire in two years. The Company hasagreed to grant Piedmont certain rights for the registration under theSecurities Act of 1933, as amended, of these shares. The issuance of commonstock was exempt from registration under the Securities Act by virtue ofSection 4(2) thereof, no public sale having been involved.

 
| Item 6           | Exhibits  and Reports on Form 8-K |
|------------------|-----------------------------------|
|             |                              |   |
|             | (a)                               | Exhibits. |
| .                |                              | The following exhibits  are filed as part of this Report |
|             |                              |   |
| Exhibit   Number |                              |   |
| Description      |
|             |                              |   |
| 10.1             |                              | Consulting Agreement  dated July 3, 2001 between Tekgraf, Inc. and Piedmont Consulting, Inc. |
|             |                              |   |
| 2.1              |                              | Asset Purchase and  Sale Agreement, dated as of October 29, 2001, between the Company and SCB  Acquisitions, LLC.  The exhibits and  schedules to the Agreement have been omitted, but the Company undertakes to  furnish a copy of any exhibit or schedule to the Securities and Exchange  Commission upon request (Filed as Appendix A to the Company’s Proxy Statement  filed on October 29, 2001 and incorporated herein by reference) |

 

** **

** **

**SIGNATURES**

 

PURSUANT TO THE REQUIREMENTS OF THESECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT ONFORM 10-Q TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULYAUTHORIZED THIS 13th DAY OF NOVEMBER, 2001.

 

TEKGRAF, INC.

 
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                SIGNATURE |   |   |                            Title |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
| By:    |  /s/ William M. Rychel                                                                                                                                                                    |   |   | Chief  Executive Officer,                                                                                                                                          |   |
|   | William  M. Rychel                                                                                                                                                                             |   |   | President  and Director (principal                                                                                                                                 |   |
|   |                                                                                                                                                                                           |   |   | executive  officer)                                                                                                                                                |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
| By:    |  /s/ Thomas M. Mason                                                                                                                                                                      |   |   | Chief  Financial Officer                                                                                                                                           |   |
|   | Thomas  M. Mason                                                                                                                                                                          |   |   | (principal  financial and accounting officerand duly authorized officer of the Registrant)                                                                         |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |
|   |                                                                                                                                                                                           |   |   |                                                                                                                                                               |   |

INDEX OF EXHIBITS

 
| Exhibit |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Number  |   | Description                                                                                                                                                                                                                                                                                                                                                                                                                                           |   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |
| 10.1    |   | Consulting Agreement  dated July 3, 2001 between Tekgraf, Inc. and Piedmont Consulting, Inc.                                                                                                                                                                                                                                                                                                                                                          |   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |
| 2.1     |   | Asset Purchase and  Sale Agreement, dated as of October 29, 2001, between the Company and SCB  Acquisitions, LLC.  The exhibits and  schedules to the Agreement have been omitted, but the Company undertakes to  furnish a copy of any exhibit or schedule to the Securities and Exchange Commission  upon request (Filed as Appendix A to the Company’s Proxy Statement filed on  October 29, 2001 and incorporated herein by reference). |   |
|         |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                       |        |  |