Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission file number 0-16345

SED International Holdings, Inc.

Company’s telephone number, including area code:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Company’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.     þ

      Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ

      The aggregate market value of the voting stock held by non-affiliates of the Company was approximately $6.5 million as of June 30, 2004 based upon the last sale price of the Common Stock as reported on the Over the Counter Bulletin Board on that day. There were 3,879,171 shares of Common Stock, $.01 par value, outstanding at June 30, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

      Part III incorporates information by reference from portions of the Company’s definitive proxy statement for its 2004 annual meeting of shareholders scheduled to be held on December 16, 2004, which will be filed no later than 120 days after the close of the Company’s fiscal year ended June 30, 2004.

TABLE OF CONTENTS

Table of Contents

PART I

(a) General Development of Business

      SED International Holdings, Inc., a Georgia corporation, and its wholly-owned operating subsidiary, SED International, Inc., a Georgia corporation (“SED International”), were incorporated in 1986 to take over the operations of the business of the Company’s predecessor, Southern Electronics Distributors, Inc., which was engaged in the wholesale distribution of consumer electronic products. In fiscal 1999, the Company, formerly a Delaware corporation, reincorporated as a Georgia corporation. As used herein, the term “Company” or the “Registrant” means SED International Holdings, Inc. and its subsidiaries, including SED International, unless the context otherwise indicates.

      The Company is a distributor of microcomputer products, including mass storage, imaging, display, wireless products and consumer electronics throughout the United States and Latin America. The Company offers to an active base of over 6,500 reseller customers a broad inventory of more than 3,500 products from approximately 170 vendors (direct and indirect), including such market leaders as Hewlett-Packard, Intel, Maxtor, Creative Labs, Acer, Epson, Microsoft, LG Electronics, Envision, and IBM, through a dedicated sales force. The Company distributes products in the United States from its strategically located warehouses in Atlanta, Georgia; Miami, Florida; City of Industry, California; Richardson, Texas; and San Juan, PR. The Company services Latin America through its wholly-owned subsidiaries SED International de Colombia Ltda. in Bogota, Colombia and Intermaco S.R.L. in Buenos Aires, Argentina.

      The Company also distributes wireless telephone products in the United States and to Latin America. The Company is a direct distributor of wireless telephone products for LG Infocomm and Audiovox and an indirect distributor for other leading wireless telephone product vendors such as Motorola, Nokia, and Samsung. In fiscal 2004, the Company’s net sales of microcomputer products generated approximately 82.0% of the Company’s total net sales and wireless telephone products represented the remaining 18.0%.

      In January of 2004 the Company announced that it would re-enter the wholesale consumer electronics distribution business and would offer such products to its current information technology and wireless customers. In addition to its current customers the Company offers consumer electronic products to the rent-to-own, ecommerce and retail channels. The Company is offering consumer electronics products from leading vendors including SVA, Zenith, Cingular, Creative Labs and Audiovox.

      The shareholders of the Company approved a one-for-two reverse stock split in a special meeting of shareholders held on April 26, 2002. As a result of the reverse split, all holders of the Company’s common stock returned their current share certificates and received new certificates which reduced the number of shares held on a 1 for 2 basis. The new certificates have the same terms as the old certificates. All applicable amounts reflected herein give retroactive effect to the reverse stock split.

      Subsequent to June 30, 2002, the Company terminated its credit facility with Wachovia Bank, NA, and IBM Global Finance. In October 2002, the Company entered into a new credit facility with Fleet Capital Corporation which provides access by the Company to additional credit capacity and liquidity. Additional information about the agreement with Fleet Capital Corporation may be found in the Liquidity and Capital Resources section of this Annual Report.

      In February 2003, the Company approved a plan to discontinue commercial operations of its Brazilian subsidiary, SED International do Brasil Distribuidora, Ltda. Accordingly, since the third quarter of fiscal 2003 the operating results of SED International do Brasil Distribuidora, Ltda. have been classified as a discontinued operation for all periods presented in the Company’s consolidated statements of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — “Discontinued Operations” and Note 18 of the Company’s Consolidated Financial Statements.

2

Table of Contents

(b) Financial Information about Industry Segments

      The Company operates in only one business segment. Revenues generated from operations, measures of profit or loss or loss and total assets of the Company are reported in “Item 8. Financial Statements and Supplementary Data”.

(c) Narrative Description of Business

      The Company offers its customers a broad inventory of more than 3,500 products from approximately 170 vendors (direct and indirect), including such market leaders as Hewlett-Packard, Intel, Maxtor, Creative Labs, Acer, Microsoft, Envision, and LG Electronics. The Company is a direct distributor of wireless telephone products for LG Infocomm and Audiovox and an indirect distributor for other leading wireless telephone product vendors such as Motorola, Nokia, and Samsung. Microcomputer related products accounted for $304.5 million or 82.0% of the Company’s net sales for fiscal 2004, $364.6 million or 88.0% of the Company’s net sales for fiscal 2003, $399.9 million or 94.0% of net sales in fiscal 2002. Approximately $67.2 million or 18.0% of the Company’s net sales for fiscal 2004, $48.5 million or 12.0% of the Company’s net sales for fiscal 2003, $24.0 million or 6.0% of net sales for fiscal 2002, consisted of wireless handsets and accessories. The Company continually evaluates its product mix and inventory levels and maintains flexibility by adjusting its product offerings based on demand. The Company’s vendors generally warrant the products distributed by the Company and allow the return of defective products. Generally, the Company’s authorized distributor agreements with its microcomputer and wireless telephone products vendors permit the Company to sell these vendors’ products in the United States and in designated countries in Latin America.

      As a distributor, the Company incurs the risk that the value of its inventory will be affected by industry-wide forces. Rapid technological change is commonplace in the microcomputer and wireless industries and can quickly diminish the marketability of certain items, whose functionality and demand decline with the appearance of new products. These changes, coupled with price reductions by vendors, may cause rapid obsolescence of inventory and corresponding valuation reductions in that inventory. Accordingly, the Company seeks provisions in its vendor agreements common to industry practice which provide price protections or credits for declines in inventory value and the right to return unsold inventory. No assurance can be given, however, that the Company can negotiate such provisions in each of its agreements or that such industry practice will continue.

      The Company purchases goods from approximately 170 vendors (directly and indirectly) and has negotiated favorable terms from certain vendors by purchasing a substantial volume of those vendors’ products. In fiscal 2004, 2003, and 2002, Maxtor accounted for 22.5%, 44.4%, and 40.0%, respectively, and Hewlett Packard accounted for 17.4%, 8.8% and 10.1%, respectively, of the Company’s purchases.

      There can be no assurance that the Company will be able to maintain its existing vendor relationships or secure additional vendors as needed. The Company’s vendor relationships typically are non-exclusive and subject to annual renewal, terminable by either party on short notice, and contain territorial restrictions that limit the countries in which the Company is permitted to distribute the products. The loss of a major vendor, the deterioration of the Company’s relationship with a major vendor, the loss or deterioration of vendor support for certain Company-provided services, the decline in demand for a particular vendor’s product, or the failure of the Company to establish good relationships with major new vendors could have a material adverse effect on the Company’s business, financial condition and results of operations.

      Product orders typically are processed and shipped from the Company’s distribution facilities on the same day an order is received or, in the case of orders received after customary cutoff time, on the next business day. The Company relies almost entirely on arrangements with independent shipping companies for the delivery of its products to United States customers. Products sold within the Latin American markets are either picked up by the customer, or delivered to the customers or their agents from the Company’s Colombia and Argentina facilities. Generally, the Company’s inventory level of products has been adequate to permit the Company to be responsive to its customers’ purchase requirements. From time to time, however, the Company

3

Table of Contents

      The Company’s sales are generated by a telemarketing sales force, which, on June 30, 2004, consisted of approximately 109 people in sales offices located in Atlanta, Georgia; Miami, Florida; City of Industry, California; Richardson, Texas; San Juan, Puerto Rico; Bogota, Colombia and Buenos Aires, Argentina. Of the total number of salespersons on June 30, 2004, 52 people focused on sales to customers for export to Latin America and on sales in Colombia and Argentina. Substantially all of the export and Latin American-based salespeople are fluent in Spanish or Portuguese. The Company’s Atlanta sales office maintains a separate telemarketing sales force for the sale of wireless telephone products to retailers and wireless telephone carriers and their authorized agents located throughout the United States and Latin America.

      Members of the sales staff are trained through intensive in-house sales training programs, along with vendor-sponsored product seminars. This training allows sales personnel to provide customers with product information and to use their marketing expertise to answer customers’ questions about important new product considerations, such as compatibility and capability, while offering advice on which products meet specific performance and price criteria. The Company’s salespeople are able to analyze quickly the Company’s extensive inventory through a sophisticated management information system and recommend the most appropriate solution for each customer, whether that customer is a full-line retailer or an industry-specific reseller.

      The Company’s domestic sales force is organized in teams generally consisting of two to four people. The Company believes that teams provide superior customer service because customers can contact one of several people. Moreover, the long-term nature of the Company’s customer relationships is better served by teams that increase the depth of the relationship and improve the consistency of service. It has been the Company’s experience that the team approach results in superior customer service and better employee morale.

      Compensation incentives are provided to the Company’s salespeople, thus encouraging them to increase their product knowledge and to establish long-term relationships with existing and new customers. Customers can telephone their salespersons using a toll-free number provided by the Company. In addition, salespeople initiate calls to introduce the Company’s existing customers to new products and to solicit orders. Salespeople also seek to develop new customer relationships by using targeted mailing lists, vendor leads and telephone directories of various cities.

      The telemarketing salespersons are supported by a variety of marketing programs. For example, the Company regularly sponsors shows for its resellers where it demonstrates new product offerings and discusses industry developments. Also, the Company’s in-house marketing staff prepares catalogs that list available microcomputer and wireless telephone products and routinely produces marketing materials and advertisements. In addition, the in-house marketing staff promotes products and services through the Company’s Internet web page (www.sedonline.com) providing 24-hour access to on-line order entry. The Company’s web page provides customers secured access to place orders and review product specifications at times that are convenient to them. Customers also can determine on a real-time basis inventory availability, pricing, and verify the status of previously placed orders through hyperlinks to certain independent shipping companies.

      The Company prides itself on being service oriented and has a number of on-going value-added services intended to benefit both the Company’s vendors and reseller customers. For example, the Company is committed to training its salespeople to be technically knowledgeable about the products they sell. This core competency supplements the sophisticated technical support and configuration services also provided by the Company. The Company believes that its salesperson’s ability to listen to a reseller’s needs and recommend a cost-efficient solution strengthens the relationship between the salesperson and his or her reseller and promotes customer loyalty to the Company. In addition, the Company provides such other value-added services as new product demonstrations and technical education programs for resellers, configuration services

4

Table of Contents

      Management continually evaluates the Company’s product mix and the needs of its customers in order to minimize inventory obsolescence and carrying costs. The Company’s rapid delivery terms are available to all of its customers, and the Company seeks to pass through its shipping and handling costs to its customers.

      The Company offers various credit terms including, open account, prepay, credit card, and COD to qualifying customers. The Company closely monitors customers’ creditworthiness through its on-line computer system, which contains detailed information on each customer’s payment history and other relevant information. In addition, the Company participates in national and international credit associations that exchange credit rating information on customers. The Company reviews customers credit worthiness based on sales trends, industry trends in a geography, and other factors. The Company establishes reserves for estimated credit losses in the normal course of business.

      The Company serves an active, nonexclusive customer base of over 6,500 resellers of microcomputer, consumer electronics and wireless handset products. Resellers include value-added resellers, corporate resellers and retailers. The Company believes the multi-billion dollar microcomputer and wireless telephone wholesale distribution industries serve customers primarily on a nonexclusive basis, which provides the Company with significant growth opportunities. During fiscal 2004, no single customer accounted for more than 10% of the total net sales of the Company. The Company believes that most of its customers rely on distributors as their principal source of microcomputer and wireless telephone products.

      The microcomputer, consumer electronics and wireless telephone distribution industries are highly competitive, both in the United States and in Latin America. Competition in these industries is typically characterized by pricing pressures, product availability and potential obsolescence, speed and accuracy of delivery, effectiveness of sales and marketing programs, credit availability, ability to tailor specific solutions to customer needs, quality of product lines and services, and availability of technical support and product information. Additionally, the Company’s ability to compete favorably is principally dependent upon its ability to manage inventory and accounts receivable and to control other operating costs. Successful management of the Company also requires the Company to react quickly and appropriately to short and long-term trends, price its products competitively, increase its net sales and maintain economies of scale.

      The Company’s competitors include regional, national and international microcomputer, consumer electronics and wireless distributors, many of which have substantially greater technical, financial and other resources than the Company, as well as vendors that sell directly to resellers and large resellers that sell to other resellers. Major competitors include Ingram Micro, Inc., Tech Data Corporation, D&H, ASI, Brightpoint, Inc., Cellstar Corporation, and Synnex Information Technologies, Inc. in the United States; and Tech Data Corporation, Ingram Mico, Inc., and Intcomex Holdings, L.L.C. in Latin America. From time to time, these competitors may be used as vendors.

      The Company’s sales currently are not subject to material seasonal fluctuations although no assurance can be given that seasonal fluctuations will not develop, especially during the holiday season in the United States and Latin America.

      As of June 30, 2004, the Company had 297 full-time employees, 109 of whom were engaged in telemarketing and sales, 98 in administration and 90 in warehouse management and shipping. Management

5

Table of Contents

(d) Financial Information about Foreign and Domestic Operations and Export Sales

      During the fiscal year ended June 30, 1998, the Company began selling directly to customers in Colombia through the Company’s facilities in Bogota, Colombia. During the fiscal year ended June 30, 1999, the Company also began selling directly to customers in Argentina through the Company’s facilities in Buenos Aires. Sales are denominated in the respective local currencies of these countries. For the fiscal year ended June 30, 2004, 2003 and 2002, approximately 28.5%, 22.5% and 26.6%, respectively, of the Company’s net sales were to customers for export principally into Latin America and direct sales to customers in Colombia and Argentina. See Item 8 and Notes 12, 16 and 18 to the consolidated financial statements of the Company for additional information concerning the Company’s domestic and foreign operations.

(e) Available Information

      The Company makes available all of its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports free of charge through its Internet website at www.sedonline.com as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. These reports are also available on the Securities and Exchange Commission’s Internet website at www.sec.gov.

      A copy of Form 10-K will be provided upon written request and without charge. Please send your requests to the attention of Investor Relations, SED International, Inc., 4916 North Royal Atlanta Drive, Tucker, Georgia 30084.

      The Company maintains its executive offices, Atlanta sales and warehouse facility, at 4916 North Royal Atlanta Drive in Atlanta, Georgia. The Company leases its executive, administrative, sales and warehouse office from Diamond Chip Group, L.L.C., a Georgia limited liability company owned by certain minority shareholders and officers of the Company, previously doing business as Royal Park Company, a Georgia general partnership. The lease commenced in April 1999 and expires in September 2006. The facility consists of approximately 30,000 square feet, with an annual rental of approximately $285,000 effective October 1, 2003, with annual increases of three percent through September 30, 2006. The Company has a right of first refusal to purchase the facility should it be offered for sale. The Company believes that the lease of its executive offices is on terms no less favorable than those available from unaffiliated parties. The Company believes there is sufficient additional warehouse and sales office space available for lease at reasonable prices near its principal facility in the event the Company’s growth plans so require.

      The Company maintains additional warehouse facilities in City of Industry, California; Miami, Florida, Richardson, Texas; San Juan, Puerto Rico; Bogota, Colombia and Buenos Aires, Argentina.

      The Company leases its sales and distribution facility in Miami, Florida under a lease expiring March 31, 2007. This facility consists of approximately 31,000 square feet at an annual rental of approximately $219,000 effective April 1, 2004 and increasing to $228,000 effective April 1, 2005.

      The Company also leases an approximately 50,000 square foot facility in City of Industry, California. The City of Industry facility serves as a distribution center and sales center for the Company. Annual rental under the lease is approximately $252,000. Pursuant to its terms, the lease will expire on March 31, 2005.

      On April 1, 1998, the Company began leasing an approximately 102,000 square foot distribution facility in Harrisburg, Pennsylvania. The Company was obligated for lease payments of approximately $408,000 per year through March 31, 2003. From June 1, 2000 through December 31, 2000 the Company sublet approximately 51,000 square feet of the facility for approximately $222,000 per year. The Company entered into a sublease for the entire building beginning on October 1, 2001 to cover the entire cost of this facility through the end of the lease on March 31, 2003.

6

Table of Contents

      On December 1, 1997, the Company began leasing an approximately 20,000 square foot administrative center and sales office in Bogota, Colombia. The Bogota center serves as a sales office and distribution facility for SED International de Colombia Ltda., a wholly owned subsidiary of the Company. Annual payments total approximately $55,000 per year. The lease will expire on November 30, 2006.

      On November 1, 1998, the Company assumed the lease obligations for several small facilities in Buenos Aires, Argentina. These facilities consist of various spaces in the Galeria business complex and are utilized for sales offices, administrative offices and warehouses by Intermaco S.R.L., a wholly owned subsidiary of the Company. Aggregate space is approximately 5,000 square feet. Payments total approximately $21,000 annually. The leases expire at various dates until June 2006.

      On May 1, 2003, the Company began leasing an approximately 25,700 square feet facility in Richardson, Texas. The facility serves as a sales office and distribution center to service the Company’s customers in the Dallas area. The Company is obligated for lease payments of approximately $115,700 per year through April 30, 2006.

      On January 1, 2001, the Company began leasing an approximately 3,900 square feet sales and distribution facility in Hato Rey, Puerto Rico. The space was expanded to approximately 5,500 square feet in October 2002 and the Company is obligated for annual lease payments of approximately $84,000. Subsequent to June 30, 2004, the Company reached a decision to close the facility in Puerto Rico and has negotiated a buyout of the lease for approximately $22,000.

      On January 1, 2004, the Company began leasing approximately 12,000 square feet of additional distribution warehouse space in Tucker, Georgia. The Company is obligated for annual lease payments of approximately $16,700 through November 30, 2004.

      The Company is involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not currently engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on the Company.

      No matters were submitted to a vote of the Company’s shareholders during the fourth quarter of fiscal 2004.

PART II

      Until October 4, 2002 the Company’s common stock was traded over the counter and quoted on the Nasdaq National Market System under the symbol “SECX”. The Company received notification on September 27, 2002 from Nasdaq that the Company’s common stock would be delisted from the Nasdaq National Market due to noncompliance with the value of public float requirement of $5,000,000.00 for continued listing on Nasdaq National Market. The Company’s stock price also has fallen below the $1.00 minimum necessary for continued listing on the Nasdaq National Market and Nasdaq Small Cap. The Company does not presently intend to take actions to regain compliance with the Nasdaq National Market or Small Cap listing standards. The Company’s common stock is now traded on the Over-the Counter Bulletin Board (OTCBB). The OTCBB is a regulated quotation service that displays real-time quotes, last-sale prices and volume information in over-the-counter (OTC) equity securities. OTCBB securities are traded by a community of market makers that enter quotes and trade reports. SED’s ticker symbol is currently (SECX).

7

Table of Contents

      The following table sets forth the high and low sales prices for Company’s common stock as reported for each quarter of fiscal 2004 and 2003 as adjusted for the 1 for 2 recapitalization on April 26, 2002. The quotations are inter-dealer prices without retail mark-ups, mark-downs or commissions and may not represent actual transactions.

      There were 3,879,171 shares of common stock outstanding, approximately 204 shareholders of record as of September 17, 2004.

      The Company has never declared or paid cash dividends on its common stock. The Company currently intends to retain earnings to finance its ongoing operations and it does not anticipate paying cash dividends in the foreseeable future. Future policy with respect to payment of dividends on the common stock will be determined by the Board of Directors based upon conditions then existing, including the Company’s earnings and financial condition, capital requirements and other relevant factors. SED International, the earnings of which would be the primary source of any dividend payments, and the Company are parties to a revolving credit agreement which contains certain financial covenants that may impact the Company’s ability to pay dividends in the event the Company should change its policy and choose to issue dividends. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

      The Company did not repurchase any of its securities during the fourth quarter of fiscal 2004.

      Information concerning the Company’s equity compensation plans appears in Part III, Item 12 hereof and in Note 10 to the Company’s Consolidated Financial Statements.

8

Table of Contents

9

Table of Contents

      All periods presented have been restated in connection with the February 2003 discontinuance of operations of SED International do Brasil Distribuidora, Ltda. In addition, if the non-amortization provisions of SFAS No. 142 had been applied to all periods presented, the 2001 and 2000 net income would have increased or net loss would have decreased by $433,000 and $373,000, respectively.

      The Company has restated its Consolidated Balance Sheet as of June 30, 2003 and 2002 to properly classify the revolving credit facility with Fleet Capital Corporation, (“the Fleet Agreement”) as a current liability in accordance with Financial Accounting Standards Board Emerging Issues Task Force Issue No. 95-22, Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement (“EITF 95-22”). This restatement had no impact on the Company’s results of operations, cash flows or compliance covenants under the Fleet Agreement for the years ended June 30, 2003 and 2002. The revolving credit facility is classified as a current liability in accordance with EITF 95-22 since the Fleet Agreement contains a subjective acceleration clause and contractual provisions under a lock box arrangement that require the cash receipts of the Company be used to repay amounts outstanding under the revolving credit facility. As a result of the reclassification of the revolving credit facility to a current liability, working capital decreased $12,823,000 and $4,900,000 for the fiscal years ended June 30, 2003 and 2002, respectively.

10

Table of Contents

      The following discussion should be read in conjunction with the consolidated financial statements of the Company and the notes thereto and the Selected Consolidated Financial Data included elsewhere herein. Historical operating results are not necessarily indicative of trends in operating results for any future period.

Overview

      During fiscal 2004, our consolidated net sales declined approximately 10.0% when compared to fiscal 2003. This can be attributed to a decline in domestic sales, which represented 71.5% of net sales during fiscal 2004 compared to 77.5% in fiscal 2003. Net sales in the United States were down by 17.0% due to the continued economic slowdown, and competitive market conditions. While sales in the United States declined, sales in Latin America grew 22.0% over the prior year as we saw slightly improving economies in Argentina and Colombia.

      The revenue decline from fiscal 2003 along with competitive market conditions resulted in a slight deterioration of our margins during fiscal 2004. Gross margin as a percentage of net sales decreased to 4.5%, compared to 4.7% in fiscal 2003.

      Selling, general and administration expenses decreased to $18.5 million or 5.0% in 2004 compared to $25.0 million or 6.0% in fiscal 2003. Fiscal 2004 and 2003 expenses included several unusual items, which impacted our results, which are discussed in more detail hereafter.

      The Company incurred a net loss of $4.3 million in fiscal 2004, compared to $3.1 million in fiscal 2003, which included a net loss from discontinued operations of $42,000 and $4.7 million in fiscal years 2004 and 2003 respectively. Operating income in our Latin American subsidiaries increased 28.0% to $2.1 million from fiscal 2003 while operating losses in the United States decreased 44.5% to $5.2 million, compared to $9.4 million fiscal 2003.

      The Company has experienced a decline in net sales over the last three years and has incurred operating losses in each of the last three years. Company management is continuing to focus on increasing profit margins and reducing administrative and overhead costs. There is no assurance the Company will be successful in its efforts. Failure to improve margins and reduce overhead could adversely affect the Company’s profitability and financial condition.

      Numerous factors and conditions impact the Company’s ability to adequately achieve its profit goals, including, but not limited to, the following:

	•	Continuation of distribution agreements — The Company operates under formal but cancelable distribution agreements with certain of its suppliers. If these agreements were cancelled, the Company would be forced to obtain its products through wholesalers. This would reduce the Company’s profit margin on the affected products.
	•	Availability of certain products — From time to time, due to production limitations or heavy demand, the Company may only be able to purchase a limited amount of popular products from its suppliers.
	•	Product margins — The Company operates in a very competitive business environment. Accordingly, product margins are continually under pricing pressure. From time to time, the Company receives price protection and other considerations from its vendors. While the Company has no reason to believe such vendor consideration will not continue, no assurance can be given that such price protection and other considerations will continue to be received in the future.
	•	Vendor credit — The Company significantly relies on its suppliers for trade credit. Changes by the suppliers in their credit terms could force the Company to obtain less favorable financing for its purchases.
	•	Product obsolescence — The Company offers a broad line of products that are subject to fast technological obsolescence, which increases the risk of inventory markdown. Through its vendor agreements, the Company has certain stock return privileges, which vary from supplier to supplier. The

11

Table of Contents

		Company believes stock return programs will continue in the future, but can give no assurance about whether these programs will continue.
	•	Consumer Electronics — The Company is entering into the distribution of consumer electronics, which is highly competitive. Some of the Company’s competitors have substantially greater financial, marketing and distribution resources than the Company and the Company may be unable to successfully compete with these companies. The Company acquired significant levels of inventory during the fourth quarter of 2004. Failure to successfully penetrate this market could have an adverse impact on the Company’s cash flows, financial position and operating results.
	•	Credit decisions and losses — The Company maintains an experienced customer credit staff and relies on customer payment history and third party data to make customer credit decisions. Nevertheless, the Company may experience customer credit losses in excess of its expectations. The Company maintained credit insurance for customers located in the United States through February 1, 2004 and maintains insurance in most Latin American countries (subject to certain terms and conditions). However, the terms of the credit insurance agreement require the Company to maintain certain minimum standards and policies with respect to extending credit to customers. If the Company does not adhere to such policies, the insurance companies may not pay claims submitted by the Company.
	•	Proportionate control of general and administrative costs — The Company attempts to control its overhead costs to keep such costs in line with its sales volume. As sales volumes fluctuate, the Company must continually monitor its overhead costs and make adjustments timely and appropriately.
	•	Uncertain and possibly volatile economic and political environment in Latin America — The general economic and political environment in the countries in which the Company operates in Latin America is uncertain and, at times, volatile. As a result of these conditions, the Company could experience unexpected costs from its operations in these countries.
	•	Availability of credit facilities — The Company operated under a formal credit facility with a bank for many years that was subject to certain collateral limitations and contained certain covenants. During October 2002 a new credit facility was obtained. The new credit facility provides more flexibility compared to the prior agreement but also includes covenants and other provisions. The Company from time to time violated the financial covenants associated with the previous credit agreement, but was successful in negotiating waivers of such violations. No assurance can be given that the Company will be able to maintain compliance with financial covenants, or obtain waivers in the event of non-compliance, in the future. Failure to maintain compliance with the financial covenants could adversely affect the Company’s ability to obtain vendor credit and the overall business operations. The principal credit facility, which expires in October 2005, is further described in Note 7 to the Company’s Consolidated Financial Statements.
	•	Cash flows — While not presently anticipated, the Company’s continued operation in Latin America may require additional capital infusion in the form of loans from the parent company or other debt borrowings by the subsidiary. The October 2002 credit facility places certain restrictions on the future funding of Latin American operations (See Note 7).

      For the Company’s domestic operations, all purchases and sales are denominated in United States dollars. For the Company’s operations in Colombia and Argentina, in-country transactions are conducted in the respective local currencies of these two locations while import purchases are generally denominated in United States dollars.

12

Table of Contents

Results of Continuing Operations

      The following table sets forth, for the years presented, the percentage of net sales represented by certain items in the Company’s consolidated statements of operations:

      Net sales from continuing operations decreased 10.0%, or $41.4 million, to $371.7 million in fiscal 2004 compared to $413.1 million in fiscal 2003. Microcomputer product sales declined 16.0% to $304.5 million compared to $364.6 million in fiscal 2003 due to the continued economic slowdown, competitive market conditions and management’s strategic decision to reduce concentration and reliance on one major vendor in the hard drive market. Wireless revenues in fiscal 2004 increased 39.0% to $67.2 million compared to $48.5 million in fiscal 2003 as the Company continued to expand its product offerings in the wireless market.

      Information concerning the Company’s domestic and foreign sales is summarized below:

      The decrease in domestic sales was due primarily to a decline in the sales of mass storage products offset by increases in printers, printer consumables, computer processors and wireless product sales. The increase in U.S. export sales was primarily due to an improvement in the sale of printers and printer consumables while sales in our Latin American subsidiaries increased due to the slightly improving economies in Argentina and Colombia.

13

Table of Contents

      Sales of microcomputer products represented approximately 82.0% of the Company’s net sales in fiscal 2004 compared to 88.0% for fiscal 2003. Sales of wireless telephone products accounted for approximately 18.0% of the Company’s net sales in fiscal 2004 compared to 12.0% for fiscal 2003.

      Gross profit decreased $2.9 million to $16.6 million in fiscal 2004, compared to $19.4 million in fiscal 2003. Gross profit as a percentage of net sales declined to 4.5% in fiscal 2004 compared to 4.7% in 2003. The decrease in gross profit margin is primarily a result of volume, lower margin sales, and over all pricing pressures in the market. The Company’s margins may be affected by several factors including (i) the mix of products sold, (ii) the price of products sold and provided and (iii) increased competition. Overall, the Company continues to experience pricing pressure in selling products.

      Selling, general and administrative expenses for fiscal 2004 declined 26.0% to $18.5 million, compared to $25.0 million in fiscal 2003. These expenses as a percentage of net sales decreased to 5.0% in 2004 compared to 6.0% in fiscal 2003. The decrease in expense from the prior year is attributed to several factors including (i) a decrease in credit and collection expenses of $1.1 million, (ii) a $1.2 million provision in 2003 for certain sales tax liabilities which will likely not be recovered from customers, (iii) non-recurring expenses of $2.4 million (net of $1.0 million incurred in fiscal 2004) recorded under the employment agreement of Gerald Diamond, the Company’s deceased founder and former Chairman and Chief Executive Officer, (iv) and a decline in other employee related and general expenses of $1.8 million.

      Depreciation was $1.2 million in fiscal 2004 as compared to $1.6 million in fiscal 2003. The decline reflects lower capital expenditures and a declining asset base.

      The results of operations of the Company are subject to and can be adversely affected by the inflationary conditions in Latin America and the fluctuations of the Argentine and Colombian currencies. Since the Company has significant U.S. dollar denominated liabilities in Latin American subsidiaries, the devaluation resulted in foreign currency transaction losses totaling approximately $14,000 in fiscal 2004 as compared to approximately $581,000 in fiscal 2003. See Item 7A for further discussion.

      Net interest expense was $.2 million in fiscal 2004 compared to interest expense of $.5 million in fiscal 2003. The decrease in net interest expense is related to interest income of $220,000 earned during fiscal 2004 on cash balances on hand associated with the proceeds received by the Company pursuant to two key man life insurance policies held on the life of Gerald Diamond, the Company’s founder and former Chairman and Chief Executive Officer who passed away in June of 2003.

      Other income in fiscal 2003 was comprised of $10.0 million in proceeds under the life insurance policies described immediately above. The insurance proceeds were received in July and August of 2003. Additionally, in fiscal 2003, the Company entered into a confidential settlement agreement for claims arising out of a disagreement with a former insurance broker. The net proceeds of $512,932 were recorded net of attorney’s fees of $96,420.

      Income tax expense was approximately $801,000 in fiscal year 2004 compared to $613,000 in 2003. The income tax expense is primarily related to income generated by the Company’s Latin American subsidiaries. At June 30, 2004, the Company has a gross net operating loss carried forward for U.S. federal tax purposes of approximately $54.8 million and state tax purposes of approximately $56.4 million; expiring at various dates through 2024 and gross net operating loss carry forwards for foreign income tax purposes of approximately $12 million in Brazil, which generally do not expire. At June 30, 2004 and 2003, the Company has recorded valuation allowances for principally all deferred tax assets, except for those relating to Intermaco S.R.L. (Argentina), as there is no assurance that these assets will be realized.

14

Table of Contents

      Net sales from continuing operations decreased 2.5%, or $10.8 million, to $413.1 million in fiscal 2003 compared to $423.9 million in fiscal 2002. Information concerning the Company’s domestic and foreign sales is summarized below:

      Domestic sales were $320.1 million and $311.3 million in fiscal 2003 and fiscal 2002, respectively. The increase in domestic sales was due primarily to an increase in wireless product sales of $24.5 million offset by a decline in the sales of printers, printer consumables, computer processors and mass storage products. The overall sales decline resulted from a decrease in net sales to customers for export principally to Latin America. The decrease in U.S. export sales was primarily due to the economic downturn in the Latin American countries the Company does business in.

      Sales of microcomputer products represented approximately 88.0% of the Company’s net sales in fiscal 2003 compared to 94.0% for fiscal 2002. Sales of wireless telephone products accounted for approximately 12.0% of the Company’s net sales in fiscal 2003 compared to 6.0% for fiscal 2002.

      Gross profit decreased $0.7 million to $19.4 million in fiscal 2003, compared to $20.1 million in fiscal 2002. Gross profit as a percentage of net sales remained flat at 4.7% for fiscal 2003 and 2002. Overall, the Company continues to experience pricing pressure in selling products.

      Selling, general and administrative expenses for fiscal 2003 increased 21.0% to $25.0 million, compared to $20.6 million in fiscal 2002. These expenses as a percentage of net sales increased to 6.0% in 2003 compared to 4.9% in fiscal 2002. The increase in selling, general and administrative expenses was primarily due to an increase in bad debt expenses of $0.7 million, professional fees $0.2 million, sales tax liabilities of $1.2 million, and obligations of $3.4 million that arose under the terms of Mr. Gerald Diamond’s employment agreement as a result of his June 2003 death. See Note 17 of the Company’s Consolidated Financial Statements.

      The 2002 cumulative effect adjustment was determined based on an analysis of the Company’s goodwill and the estimated future cash flows of operations associated with such impairment. See Note 3 to the Company’s Consolidated Financial Statements.

      Depreciation was $1.6 million in fiscal 2003 as compared to $2.1 million in fiscal 2002. This reflects a decline in capital expenditures.

      The results of operations of the Company were adversely affected by the continuing inflationary conditions in Latin America and the fluctuations of the Argentine and Colombian currencies. Since the Company has significant U.S. dollar denominated liabilities in Latin American subsidiaries, the devaluation resulted in foreign currency transaction losses totaling approximately $581,000 in fiscal 2003 as compared to approximately $9,000 in fiscal 2002. See Item 7A for further discussion.

      Net interest expense was $.5 million in fiscal 2003 compared to interest expense of $.3 million in fiscal 2002. This net change resulted primarily from a increase in working capital requirements in fiscal 2003 which in turn resulted in additional borrowings under the Company’s credit facility.

      Other income was $10.5 million at June 30, 2003, and included $10.0 million in proceeds due under two key man life insurance policies held on the life of Gerald Diamond, the Company’s founder and former

15

Table of Contents

      Income tax expense was approximately $613,000 in fiscal year 2003 compared to a benefit of $1.4 million in 2002. In 2002, the Company realized an income tax benefit of $1.9 million resulting from the adjustment of certain income tax liabilities and refunds received in the fourth quarter of 2002 related to recent United States tax legislation which provided for an extension of the period in which net operating losses could be carried back, offset in part by income taxes in Colombia and Argentina. At June 30, 2003, the Company has a gross net operating loss carried forward for U.S. federal tax purposes of approximately $28.7 million and state tax purposes of approximately $34.3 million; expiring at various dates through 2023 and gross net operating loss carry forwards for foreign income tax purposes of approximately $12 million in Brazil, which generally do not expire. At June 30, 2003 and 2002, the Company has recorded valuation allowances for principally all deferred tax assets, except for those relating to Intermaco S.R.L. (Argentina), as there is no assurance that these assets will be realized.

Discontinued Operations

      In February 2003, the Company resolved to discontinue commercial operations of its Brazilian subsidiary, SED International do Brasil Distribuidora, Ltda. (the “Brazil Operation”). Accordingly, the operating results of SED International do Brasil Distribuidora, Ltda. have been classified as a discontinued operation for all periods presented in the Company’s consolidated statements of operations. Additionally, the Company has reported all of SED International do Brasil Distribuidora, Ltda. assets at their estimated net realizable values in the Company’s consolidated balance sheet as of June 30, 2004 in accordance with Accounting Principles Board Opinion No. 30. See Note 18 to the Company’s Consolidated Financial Statements.

      During fiscal 2004, the Company recorded a loss from discontinued operations of approximately $42,000 primarily due to the favorable settlement of certain liabilities which were offset by a provision for potential tax claims asserted by the Brazilian government.

      During fiscal 2003, the Company incurred a loss from discontinued operations of approximately $4.7 million related to the discontinuance of SED International do Brasil Distribuidora, Ltda. This loss consisted of operating losses incurred in the Brazil Operation of $1.4 million and an estimated loss on disposal of the Brazil Operation of $3.3 million which includes charges for the following: (i) the write-off of foreign currency translation losses of $2.6 million previously recorded as a component of shareholders’ equity, (ii) equipment, (iii) customer accounts receivable, (iv) employee termination costs, (v) inventory, and (vi) facility exit and lease termination costs.

      SED International do Brasil Distribuidora, Ltda. has been transitioned from a commercial operating company into dormancy. During the dormancy period, the Company will incur ongoing operating expenses for attorney fees, statutory bookkeeping and reporting services, document storage and inventory storage cost until liquidation of the inventory. Please refer to Note 18 to the Company’s Consolidated Financial Statements for further information regarding the results of operations for the reporting periods.

      The following table sets forth certain unaudited quarterly historical consolidated financial data for each of the Company’s last eight fiscal quarters ended June 30, 2004. This unaudited quarterly information has been prepared on the same basis as the annual information presented elsewhere herein and, in the Company’s opinion, includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the selected quarterly information. This information should be read in conjunction with the

16

Table of Contents

      In the fourth quarter of fiscal 2003, the Company recorded certain expense adjustments related to changes in estimates of obligations related to sales and use tax liabilities of $1.2 million; bad debt expense of $2.1 million, $3.4 million related to benefits due under Mr. Diamond’s employment agreement (See Note 17 of the Company’s Consolidated Financial Statements) and income for insurance proceeds of $10.0 million. These fourth quarter adjustments resulted in a decrease to the net loss of approximately $.86 per share for fiscal year 2003.

Debt Obligations And Contractual Obligations

      The following table summarized the Company’s debt obligations and contractual obligations, as discussed in the Notes to the Consolidated Financial Statements as of June 30, 2004.

Off-Balance Sheet Arrangements

      An off-balance sheet arrangement is any contractual arrangement involving an unconsolidated entity under which a company has (a) made guarantees, (b) a retained or a contingent interest in transferred assets, (c) any obligation under certain derivative instruments or (d) any obligation under a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services within the Company.

      The Company does not have any off-balance sheet financing arrangements or unconsolidated special purpose entities.

17

Table of Contents

Liquidity and Capital Resources

      The Company’s liquidity requirements arise primarily from the funding of working capital needs, including inventories and trade accounts receivable. As a percentage of total assets exclusive of other receivables, accounts receivable and inventories were approximately 88.7% and 88.5% in fiscal 2004 and 2003, respectively. It has been the Company’s experience that in periods of revenue growth, investments in accounts receivable and inventories grow, and the Company’s need for financing may increase. In the periods in which revenue declines, investments in accounts receivable and inventories generally decrease, and cash is generated. At June 30, 2004, accounts receivable and inventories net of payables, increased by $1.1 million, or 3.5%, compared with June 30, 2003. In fiscal 2003, accounts receivable and inventories, net of payables, increased by 2.7%, or $.8 million, compared with fiscal 2002. At June 30, 2002, accounts receivable and inventories, net of payables, decreased by $3.2 million, or 9.9%, compared with June 30, 2001, due to decreased sales and improved asset utilization.

      Historically, the Company has financed its liquidity needs largely through internally generated funds, borrowings under its credit agreement and vendor lines of credit. The Company derives a substantial portion of its operating income and reported cash flows from its foreign subsidiaries and, due to certain bank and regulatory regulations, relies on such cash flows to satisfy its foreign obligations. While the Company continues operations in Latin America, management believes that domestic banking agreements and international monetary restrictions may limit the Company’s ability to transfer cash between its domestic and international subsidiaries.

      At June 30, 2004, the Company had cash and cash equivalents of $4.1 million, of which $3.1 million is held in Latin American banks by the Company’s subsidiaries in Argentina and Colombia. The funds held in Latin American banks are generally not available for use domestically without withholding taxes. At June 30, 2004, the Company’s principal source of liquidity is its $4.1 million of cash, and its revolving credit facility. The Company’s availability under the Fleet Agreement was $12.4 million at August 24, 2004, net of $2.2 million in reserves for outstanding letters of credit.

      The net amount of cash provided by the Company’s operating activities in fiscal 2004 was $4.2 million, principally as a result of changes in working capital requirements, the receipt of key man life insurance proceeds offset by benefits paid to Mr. Gerald Diamond’s surviving spouse under his employment agreement and the net loss from operations adjusted for non-cash items. The net amount of cash used for investing activities in fiscal 2004 was $633,000 principally as a result of leasehold improvements to our corporate office location in connection with the January 2004 consolidation of the Company’s Tucker, Georgia warehouse and corporate office facilities. The net amount of cash used for financing activities in fiscal 2004 was $2.0 million reflecting repayments under our revolving credit facility.

      The net amount of cash used by operating activities in fiscal 2003 was $.6 million, principally reflecting changes in working capital requirements, the increase in other receivables related to amounts due under two key man life insurance policies held on the life of Mr. Gerald Diamond, the Company’s founder and former Chairman and Chief Executive Officer, who passed away in June 2003, an increase in accrued liabilities associated with amounts due to Mr. Gerald Diamond’s surviving spouse under his employment agreement and the net loss from operations adjusted for non-cash items. The net amount of cash used for investing activities in fiscal 2003 was $217,000 primarily as a result of expenditures for computer equipment. The net amount of cash provided by financing activities in fiscal 2003 was $5.9 million and reflects additional borrowings under our short-term revolving credit facility of $7.9 million and repayment of subsidiary bank debt of $2.0 million.

      The net amount of cash provided by operating activities in fiscal 2002 was $1.0 million, principally reflecting lower working capital requirements and the net loss from operations adjusted for non-cash items. The net amount of cash used for investing activities in fiscal 2002 was $349,000 for various capital expenditures. The net amount of cash provided by financing activities in 2002 was $4.5 million, primarily reflecting additional borrowings under our short-term revolving credit facility.

      The Company’s cash flows were adversely affected by the unfavorable changes in exchange rates in the Latin American countries in which the Company does business. The exchange rate changes had the effect of

18

Table of Contents

      On October 7, 2002, the Company entered into a three year, $35 million credit facility with Fleet Capital Corporation (the “Fleet Agreement”). The Fleet Agreement provides for revolving borrowings up to $35 million based upon the Company’s eligible domestic accounts receivable and inventory as defined therein. Borrowings under the Fleet Agreement accrue interest based upon a variety of interest rate options depending upon the computation of availability as defined therein. The interest rates range from the prime rate to the prime rate plus a margin of .5% or LIBOR plus a margin ranging from 2% to 2.75%. The Company is also subject to a commitment fee ranging from .25% to .5% on the unused portion of the facility. Interest is payable monthly. Borrowings under the Fleet Agreement are secured by substantially all domestic assets of the Company and 65% of each of the Company’s shares in its foreign subsidiaries, respectively. The Fleet Agreement matures on October 7, 2005.

      The Fleet Agreement also contains certain covenants which, among other things, requires that if the Company’s availability is less than $5.0 million at anytime during the agreement, the Company must restrict or limit capital expenditures and advances to the Company’s Latin American subsidiaries. Also, if the $5.0 million threshold is breached, the Fleet Agreement requires the maintenance of certain levels of earnings before interest, taxes, depreciation, and amortization, requires maintenance of minimum fixed charge coverage ratio beginning in the second quarter of fiscal 2004, and requires the maintenance of minimum tangible net worth, as defined, of negative $1.8 million. The Company has maintained at least $5 million in availability under the Fleet Agreement since its inception on October 7, 2002. The Company’s availability under the Fleet Agreement net of reserves of $2.2 million for outstanding Letters of Credit was $12.4 million on August 24, 2004. Average borrowings, maximum borrowings, and weighted average interest rate for fiscal 2004 were $10.8 million, $20.9 million and 3.58% respectively.

      At June 30, 2004, the Company would not have been in compliance with certain financial covenants under the Fleet Agreement had it breached the $5.0 million availability threshold. In the future, if the Company were to breach the $5.0 million threshold and fail to comply with the required financial covenants, Fleet may declare an event of default and could demand repayment of all outstanding borrowings and discontinue the agreement. If Fleet were to declare an event of default, the Company’s liquidity and business operations could be materially adversely affected. The Company has maintained at least $5.0 million in availability under the Fleet Agreement since its inception on October 7, 2002.

      At June 30, 2004, the Company’s subsidiary, SED International de Colombia Ltda. had no bank borrowings. In addition, the Colombian subsidiary had no significant borrowings at any time during fiscal 2004.

      The carrying value of all bank debt at June 30, 2004 and 2003 approximates its fair value based on floating market interest rates under these debt agreements.

      There have been no material changes to obligations and/or commitments since year-end. Purchase orders or contracts for the purchase of inventory and other goods and services are not included in management’s estimates. Management is not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. The Company’s purchase orders are based on its current distribution needs and are fulfilled by its vendors within short time horizons. The Company does not have significant agreements for the purchase of inventory or other goods specifying minimum quantities or set prices that exceed our expected requirements for the twelve months ended June 30, 2004.

      Management believes that the Company’s credit agreements together with vendor lines of credit and internally generated funds, will be sufficient to satisfy its working capital needs during fiscal 2005. However, no assurance can be given that the Company will be able to remain in compliance with the financial covenants associated with the Fleet Agreement, or that the Company will be able to continue to obtain credit from its vendors in the future. Failure to maintain compliance under the Fleet Agreement or obtain vendor lines of credit could significantly and adversely affect the Company’s business operations.

19

Table of Contents

      An allowance for uncollectible accounts has been established based on collection experience and an assessment of the collectibility of specific accounts. Management evaluates the collectibility 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 the Company has maintained from time to time. Through February 1, 2004, the Company maintained credit insurance, which protected the Company from credit losses exceeding certain deductibles for domestic sales and certain export shipments from the United States. The company maintains credit insurance in most Latin American countries (subject to certain terms and conditions). See Note 14 under Item 8 for a summary of the movement of the allowance for doubtful accounts.

      Most of the Company’s 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, the Company 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 the Company from inventory losses, including price protections, the risk of loss associated with obsolete, slow moving or impaired inventories would increase. The Company’s reserve for obsolete and slowing moving inventories was approximately $916,000 at June 30, 2004 or 2.9% of gross inventories.

      The Company has recorded liabilities for certain sales tax liabilities, escheat liabilities, end user rebate programs for wireless phones and employment agreement obligations. The recording of these liabilities requires the Company to make judgments and estimates. Certain of the estimates are highly subjective and may be subject to change in the future. At June 30, 2004 the Company has accrued its best estimate of the amounts which will ultimately be required to be paid in connection with such matters.

      The Company’s principal financial instruments consist of cash, 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 the Company’s international subsidiaries is the local currency for 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 current 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 shareholders’ equity as a component of comprehensive income. The Company has no future plans to enter into foreign exchange forward or option contracts to hedge foreign currency transactions. These were isolated transactions. Generally, it is the Company’s policy not to enter into derivative contracts for speculative trading purposes.

20

Table of Contents

      The Company’s revolving credit facility is currently a variable rate facility. The Company does not currently hedge future interest payments with interest rate swap agreements, and has no plans to do so in the future.

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

      The Latin American countries in which the Company operates have experienced high rates of inflation and hyperinflation from time to time in the past. At this time, management estimates that inflation may have a material impact on the Company’s Latin American business operations in the immediate future (See Item 7A).

      The matters discussed herein and in the Letter to Shareholders accompanying this Annual Report on Form 10-K contain certain forward-looking statements that represent the Company’s expectations or beliefs, including, but not limited to, statements concerning future revenues and future business plans. When used by or on behalf of the Company, the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company’s control. The Company cautions that various factors, including the factors described under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the Company’s Registration Statement on Form S-3 (SEC File No. 333-35069) as well as general economic conditions and industry trends, foreign currency fluctuations, the level of acquisition opportunities available to the Company and the Company’s ability to negotiate the terms of such acquisitions on a favorable basis, a dependence upon and/or loss of key vendors or customers, the transition to indirect distribution relationships for some products, the loss of strategic product shipping relationships, customer demand, product availability, competition (including pricing and availability), concentrations of credit risks, distribution efficiencies, capacity constraints and technological difficulties could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements of the Company made by or on behalf of the Company. The Company undertakes no obligation to update any forward-looking statement.

      The Company is subject to market risk arising from adverse changes in interest rates and foreign exchange. The Company does not enter into financial investments for speculation or trading purposes and is not a party to any financial or commodity derivatives.

Interest Rate Risk

      The Company’s cash equivalents and short-term investments and its outstanding debt bear variable interest rates which adjust to market conditions. Changes in the market rate affect interest earned and paid by the Company. The Company does not use derivative instruments to offset the exposure to changes in interest rates. Changes in the interest rates are not expected to have a material impact on the Company’s results of operations.

Foreign Currency Exchange

      The functional currency for the Company’s international subsidiaries is the local currency for the country in which the subsidiaries own their primary assets. The translation of the applicable currencies into

21

Table of Contents

      The Company distributes many of its products in foreign countries, primarily in Latin America. Approximately 28.5% of the Company’s total net sales were generated from sales made to resellers located in Latin American countries during the twelve-month period ended June 30, 2004. The Company manages its risk to foreign currency rate changes by maintaining foreign currency bank accounts in currencies in which it regularly transacts business. Additionally, the Company’s foreign subsidiaries procure inventory payable in U.S. dollars for resale in their respective countries. Upon settlement of the payables, the Company may be required to record transaction gains or losses resulting form currency fluctuations from the time the subsidiary entered into the agreement to settlement date of the liability. During the year ended June 30, 2004, the Company recorded transaction losses of approximately $14,000. At June 30, 2004, the Company’s foreign subsidiaries had approximately $3.2 million in U.S. dollar denominated liabilities. In the aggregate, if the value of the dollar against the foreign denominated currency strengthens by 10%, the Company would record a transaction loss of approximately ($320,000). Conversely, if the value of the dollar declines by 10%, the Company would record a transaction gain of approximately $320,000. The Company was not a party to any hedge transactions as of June 30, 2004.

      The information included in the Company’s Annual Report does not include the potential impact that might arise from any decline in foreign currency in Latin American after June 30, 2004 or those declines which may occur in the future and, accordingly, should be analyzed considering that circumstance.

      Since January 1, 2002, the Argentine economy has experienced inflation. During fiscal 2004, the inflation rate was 4.7% compared to 10.0% in fiscal 2003. While the Argentine government together with the International Monetary Fund is seeking remedies, no assurance can be given that the economic situation in Argentina will stabilize. The devaluation, which commenced in January 2002, could make it more difficult for Argentine companies to service their commercial and financial obligations due in or tied to the U.S. dollar. Any of the foregoing events and a continuation of the Argentine recession may have a material adverse effect on the Company’s business, results of operations, financial condition, and ability to make payments on the Company’s indebtedness and on the Company’s common stock market price. The information included in the Company’s financial statements, and other documentation, does not contain the potential impact that might arise from the situation described above and, accordingly, should be analyzed considering that circumstance. Please refer to Note 16 of the Company’s Consolidated Financial Statements.

22

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders of

      We have audited the accompanying consolidated balance sheets of SED International Holdings, Inc. and subsidiaries as of June 30, 2004 and 2003, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended June 30, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SED International Holdings, Inc. and subsidiaries as of June 30, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 2004, in conformity with U.S. generally accepted accounting principles.

      As discussed in Note 7, the consolidated balance sheet for the year ended June 30, 2003 has been restated to reclassify borrowings under a revolving credit facility from non-current liabilities to current liabilities.

	/s/ ERNST & YOUNG LLP

Atlanta, Georgia

23

Table of Contents

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

See notes to consolidated financial statements.

24

Table of Contents

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS