- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-23827
PC CONNECTION, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0372768
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
528 ROUTE 13, 03055
MILFORD, NEW HAMPSHIRE (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
(603) 423-2000
Indicate by check mark ( ) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES NO X
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer's Common Stock, $.01 par
value, as of May 12, 1998 was 15,392,543.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PC CONNECTION, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE
PART I FINANCIAL INFORMATION ----
Item 1 Financial Statements:
Balance Sheets--March 31, 1998 and December 31, 1997........... 3
Statements of Income--Three months ended March 31, 1998 and
1997........................................................... 4
Statement of Changes in Stockholders' Equity--Three months
ended March 31, 1998........................................... 5
Statements of Cash Flows--Three months ended March 31, 1998 and
1997........................................................... 6
Notes to Financial Statements.................................. 7
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 10
Item 3 Qualitative and Quantitative Disclosures About Market Risk..... 17
PART II OTHER INFORMATION
Item 1 Legal Proceedings.............................................. 18
Item 2 Changes in Securities and Use of Proceeds...................... 18
Item 3 Defaults Upon Senior Securities................................ 18
Item 4 Submission of Matters to a Vote of Security Holders............ 19
Item 5 Other Information.............................................. 19
Item 6 Exhibits and Reports on Form 8-K............................... 19
SIGNATURES..................................................... 20
2
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents............................. $ 16,309 $ 758
Accounts receivable, net.............................. 33,239 29,921
Inventories merchandise............................... 63,983 63,720
Deferred income taxes................................. 3,617 375
Prepaid expenses and other current assets............. 2,329 2,205
-------- --------
TOTAL CURRENT ASSETS................................ 119,477 96,979
Property and equipment, net........................... 9,673 8,463
Deferred income taxes................................. 499 --
-------- --------
TOTAL ASSETS........................................ $129,649 $105,442
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term borrowings................................. $ -- $ 28,318
Current maturities of long-term debt.................. -- 1,250
Amounts payable to stockholders....................... -- 1,185
Accounts payable...................................... 63,816 38,174
Accrued expenses and other liabilities................ 11,093 9,145
-------- --------
TOTAL CURRENT LIABILITIES........................... 74,909 78,072
-------- --------
Term loan, less current maturities...................... -- 3,250
-------- --------
TOTAL LIABILITIES................................... 74,909 81,322
-------- --------
Stockholders' Equity:
Preferred Stock, $.01 par value, 7,500,000 shares au-
thorized, none issued and outstanding
Common Stock, $.01 par value, 30,000,000 shares
authorized, 15,392,543 and 11,798,793 shares issued
and outstanding at March 31, 1998 and December 31,
1997, respectively................................... 154 118
Additional paid-in capital............................ 54,117 4,097
Retained earnings..................................... 469 19,905
-------- --------
TOTAL STOCKHOLDERS' EQUITY.......................... 54,740 24,120
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......... $129,649 $105,442
======== ========
See notes to financial statements.
3
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
STATEMENTS OF INCOME
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
--------- ---------
Net sales................................................ $168,643 $ 122,824
Cost of sales............................................ 146,694 105,445
--------- ---------
GROSS PROFIT........................................... 21,949 17,379
Selling, general and administrative expenses............. 16,858 13,637
Additional stockholder/officer compensation.............. 2,354 2,450
--------- ---------
INCOME FROM OPERATIONS................................. 2,737 1,292
Interest expense......................................... (206) (365)
Other, net............................................... 86 3
Income tax benefit (provision)........................... 3,788 (130)
--------- ---------
NET INCOME............................................. $ 6,405 $ 800
========= =========
Pro forma data:
Historical income before income taxes.................. $ 2,617 $ 930
Pro forma adjustment--stockholder/officer compensation
in excess of aggregate base salaries.................. 2,354 2,420
--------- ---------
Pro forma income before income taxes................... 4,971 3,350
Pro forma income taxes................................. 1,938 1,306
--------- ---------
Pro forma net income................................... $3,033 $ 2,044
========= =========
Pro forma weighted average shares outstanding:
Basic.................................................. 14,236 13,861
========= =========
Diluted................................................ 14,835 14,149
========= =========
Pro forma earnings per share:
Basic.................................................. $ .21 $ .15
========= =========
Diluted................................................ $ .20 $ .14
========= =========
See notes to financial statements.
4
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
COMMON STOCK
-------------
ADDITIONAL
PAID IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- --------
BALANCE, JANUARY 1, 1998......... 11,799 $118 $ 4,097 $ 19,905 $ 24,120
Net proceeds from initial public
offering........................ 3,594 36 57,217 -- 57,253
Dividend to Subchapter S stock-
holders......................... -- -- (7,196) (25,841) (33,037)
Compensation under nonstatutory
stock option agreements......... -- -- 933 -- 933
Recognition of deferred taxes on
nonstatutory stock
option agreements............... -- -- (934) -- (934)
Net income....................... -- -- -- 6,405 6,405
------ ---- ------- -------- --------
BALANCE, MARCH 31, 1998.......... 15,393 $154 $54,117 $ 469 $ 54,740
====== ==== ======= ======== ========
See notes to financial statements.
5
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 6,405 $ 800
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 684 882
Deferred income taxes.................................. (4,675) --
Compensation under nonstatutory stock option
agreements............................................ 933 72
Provision for doubtful accounts........................ 880 471
Loss on disposal of fixed assets....................... 74 --
Changes in assets and liabilities:
Accounts receivable.................................... (4,198) (6,222)
Inventories............................................ (263) (2,212)
Prepaid expenses and other current assets.............. (124) 558
Accounts payable....................................... 25,642 10,537
Amounts payable to stockholders........................ (1,185) 1,851
Accrued expenses and other liabilities................. 1,948 (73)
--------- --------
Net cash provided by operating activities................ 26,121 6,664
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.................... (1,968) (846)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings.................... 20,796 32,645
Repayment of short-term borrowings..................... (49,114) (38,077)
Repayment of term loan................................. (4,500) --
Net proceeds from initial public offering.............. 57,253 --
Payment of dividend to Subchapter S stockholders....... (33,037) --
--------- --------
Net cash used for financing activities................... (8,602) (5,432)
--------- --------
INCREASE IN CASH......................................... 15,551 386
CASH AND CASH EQUIVALENTS, BEGINNING OF QUARTER.......... 758 162
--------- --------
CASH AND CASH EQUIVALENTS, END OF QUARTER................ $ 16,309 $ 548
========= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid.......................................... $ 358 $ 406
Income taxes paid...................................... 4 20
See notes to financial statements.
6
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION
The accompanying financial statements of PC Connection, Inc. ("PCC" or the
"Company") have been prepared in accordance with generally accepted accounting
principles. Such principles were applied on a basis consistent with those of
the financial statements contained in the Company's registration statement
filed with the Securities and Exchange Commission ("SEC") in connection with
its initial public offering ("the Offering") (File No. 333-41171) on Form S-1.
The accompanying financial statements should be read in conjunction with the
financial statements contained in the Company's registration statement. In the
opinion of management, the accompanying unaudited financial statements contain
all adjustments (consisting only of normal recurring adjustments) necessary
for a fair presentation. The operating results for the three month period
ended March 31, 1998 may not be indicative of the results expected for any
succeeding quarter or the entire year ending December 31, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements.
Actual results may differ from those estimates.
Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.
NOTE 2--CASH AND CASH EQUIVALENTS
The Company considers all highly liquid short-term investments with original
maturities of 90 days or less to be cash equivalents.
NOTE 3--RECAPITALIZATION AND STOCK SPLIT
On February 4, 1998, the Company amended its Articles of Incorporation to
increase the authorized shares of the Company's Series A Non-Voting Common
Stock, $.01 par value per share, and Series B Voting Common Stock, $.01 par
value per share, to 22,500,000 and 7,500,000 shares, respectively. The Company
also, through a 1.310977-for-one stock split, increased the total number of
Series A Non-Voting and Series B Voting shares issued and outstanding to
8,849,095 shares and 2,949,698 shares, respectively. The effect of this
recapitalization and stock split has been reflected in the Company's financial
statements and related notes thereto for all periods presented.
NOTE 4--REINCORPORATION OF THE COMPANY
On February 27, 1998, the Company changed its state of incorporation from
New Hampshire to Delaware (the "Reincorporation"). Pursuant to the
Reincorporation, the Company converted all of the issued and outstanding
shares of Series A Non-Voting Common Stock, $.01 par value per share, and
Series B Voting Common Stock $.01 par value per share of the New Hampshire
corporation into 11,798,793 shares of Common Stock, $.01 par value, of the
Delaware corporation on a one-for-one basis.
NOTE 5--INITIAL PUBLIC OFFERING
On March 6, 1998, the Company completed its offering of 3,593,750 shares of
Common Stock (including 468,750 shares issued upon the exercise of an
underwriters' overallotment option) at a price of $17.50 per share, raising
$57.3 million in net proceeds. The Company used the net proceeds from the
Offering for repayment of
7
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
bank indebtedness ($12.9 million) and to pay a dividend to stockholders of
record as of February 27, 1998 ($33.0 million) equal to substantially all
previously taxed, but undistributed, S Corporation earnings of the Company.
The remaining net proceeds ($11.4 million) have been invested in short-term
investment securities and will be used for general corporate purposes.
NOTE 6--TERMINATION OF S CORPORATION ELECTION
For periods prior to March 6, 1998, the Company elected to be treated as an
S Corporation under Subchapter S of the Internal Revenue Code ("the Code"),
and applicable state laws. Effective with the consummation of the Offering,
the Company's S Corporation election was automatically terminated and the
Company became subject to federal and state income taxes as a C Corporation
from that date forward.
Effective with this termination, the Company recorded a tax benefit of
approximately $4.2 million relating to the establishment of additional net
deferred tax assets for future tax deductions resulting from the termination
of the S Corporation election.
NOTE 7--COMPENSATION UNDER NON-STATUTORY STOCK OPTION AGREEMENTS
Effective with the consummation of the Offering, certain restrictions as to
the exercise of options granted under the Company's 1993 Incentive and Non-
Statutory Stock Option Plan expired. Prior to the consummation of the
Offering, the Company recorded compensation expense for certain options
granted at prices less than their fair market value ratably over seven years
from the dates granted, because such options were not exercisable except upon
the occurrence of certain events, including a public offering of the Company's
Common Stock. Effective with the consummation of the Offering, the Company
recorded a one-time charge for stock-option compensation expense of
approximately $870,000, relating to the acceleration of the vesting period of
certain of the Company's stock options from seven years to four years.
NOTE 8--PRO FORMA INCOME STATEMENT DATA
The following pro forma adjustments have been made to the historical results
of operations to make the pro forma presentation comparable to what would have
been reported had the Company operated as a C Corporation for the periods
presented:
1. Elimination of stockholder/officer compensation in excess of aggregate
established 1998 base salaries ($150,000) for each quarter. These amounts
generally represented Company-related S Corporation tax obligations payable
by the stockholder/officers for periods prior to March 6, 1998. Effective
upon the closing of the Offering, these stock-holder/officers are being
paid annual base salaries aggregating $600,000.
2. Elimination of the historical income tax benefit/provision for all
periods presented (including elimination of the $4.2 million income tax
benefit related to the establishment of additional deferred tax assets for
future tax deductions resulting from the termination of the Company's
Subchapter S Corporation status) and establishment of a provision for
federal and state income taxes that would have been payable by the Company
if taxed under Subchapter C of the Code, assuming an effective tax rate of
39% after an adjustment for stockholder/officer compensation described in
No. 1 above.
NOTE 9--PRO FORMA EARNINGS PER SHARE
The Company has adopted the provisions of SFAS No. 128, "Earnings Per
Share", for the purposes of presenting pro forma basic and diluted earnings
per share. The denominator used to determine pro forma basic net income per
share includes the weighted average common shares outstanding for the period,
plus the weighted
8
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
average shares required to pay the S Corporation Dividend (assuming a price
per share of $17.50 for 1998 and $16.00 for 1997). The denominator used to
determine pro forma diluted net income per share includes the shares used in
the calculation of pro forma basic net income per share plus dilutive weighted
average options outstanding in the quarters ended March 31, 1998 and 1997.
The following table sets forth the computation of pro forma basic and
diluted earnings per share:
THREE MONTHS ENDED
MARCH 31,
-----------------------
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE DATA)
Numerator:
Pro forma net income................................. $ 3,033 $ 2,044
=========== ===========
Denominator:
Denominator for pro forma basic earnings per share:
Weighted average shares............................ 12,957 11,799
Weighted average shares required to pay stockholder
dividend.......................................... 1,279 2 ,062
----------- -----------
Denominator for pro forma basic earnings per share... 14,236 13,861
----------- -----------
Effect of dilutive securities
Employee stock options............................. 599 288
----------- -----------
Denominator for pro forma diluted earnings per
share............................................... 14,835 14,149
=========== ===========
Pro forma earnings per share:
Basic.............................................. $ .21 $ .15
=========== ===========
Diluted............................................ $ .20 $ .14
=========== ===========
NOTE 10--REPORTING COMPREHENSIVE INCOME
The Company has adopted the provisions of SFAS No. 130, "Reporting
Comprehensive Income". Statement No. 130 requires the reporting of
comprehensive income in addition to net income. Comprehensive income is a more
inclusive financial reporting methodology that includes disclosure of certain
financial information that historically has not been recognized in the
calculation of net income. Based on the current financial structure and
operations of the Company, the Company had no other components to be included
in comprehensive income. Therefore, comprehensive income is the same as net
income reported for the three months ended March 31, 1998 and 1997.
9
PC CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 2--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements based on
management's current expectations, estimates and projections about the
Company's industry, management's beliefs and certain assumptions made by
management. All statements, trends, analyses and other information contained
in this report relative to trends in net sales, gross margin and anticipated
expense levels, as well as other statements, including words such as
"anticipate", "believe," "plan," "estimate," "expect" and "intend" and other
similar expressions, constitute forward-looking statements. These forward-
looking statements involve risks and uncertainties, and actual results may
differ materially from those anticipated or expressed in such statements.
Potential risks and uncertainties include, among others, those set forth under
the caption "Risk Factors" in the Company's registration statement filed with
the SEC in connection with its Initial Public Offering (File No. 333-41171).
Particular attention should be paid to the cautionary statements involving the
industry's rapid technological change and exposure to inventory obsolescence,
availability and allocation of goods, reliance on vendor support and
relationships, continued sales of Mac products, competitive risks, pricing
risks, and economic risks. Except as required by law, the Company undertakes
no obligation to update any forward-looking statement, whether as a result of
new information, future events or otherwise. Readers, however, should
carefully review the factors set forth in other reports or documents that the
Company files from time to time with the SEC.
GENERAL
The Company was founded in 1982 as a mail-order business offering a broad
range of software and accessories for IBM and IBM-compatible personal
computers ("PCs"). The founders' goal was to provide consumers with superior
service and high quality branded products at competitive prices. The Company
initially sought customers through advertising in magazines and the use of
inbound toll free telemarketing. Currently, the Company seeks to generate
sales through (i) outbound telemarketing by account managers focused on the
business, education and government markets and (ii) inbound calls from
customers responding to the Company's catalogs and other advertising. The
Company also advertises in selected computer industry publications and in 1997
commenced selling products through its internet web site.
The Company offers both PC compatible products and Mac personal computer
compatible products. Reliance on Mac product sales has decreased over the last
two years, from 26.7% of net sales in 1995 to 19.5% of net sales in the
quarter ended March 31, 1998. In late 1997, Apple announced that it will sell
built-to-order computers directly to customers over the Internet. While Apple
also indicated that it is not abandoning traditional retail and direct
marketing outlets, the Company cannot predict whether direct sales by Apple
will affect the future supply of Mac products to the Company. Although net
sales attributable to Mac products increased in the quarter ended March 31,
1998, as compared to the comparable period in 1997, the Company believes that
such sales will continue to decrease as a percentage of net sales and may
decline in dollar volume in future years.
All of the Company's product categories experienced strong growth in the
quarter ended March 31, 1998 over the comparable period in 1997, with sales of
computer systems representing the fastest growing category. Sales of computer
systems result in a relatively high dollar sales order, as reflected in the
increase in the Company's average order size from $476 in the quarter ended
March 31, 1997 to $522 in the quarter ended March 31, 1998. Computer system
sales generally provide the largest gross profit dollar contribution per order
of all of the Company's products, although they yield the lowest gross margin
percentage. Partially as a result of higher system sales, the Company's gross
margin has declined over the last two years while the operating income margin
has increased due to the leveraging of selling, general and administrative
expenses over a larger sales base.
10
The Company's profit margins are also influenced by, among other things,
industry pricing and the relative mix of inbound and outbound sales.
Generally, pricing in the computer and related products market is very
aggressive and the Company intends to maintain prices at competitive levels.
Since outbound sales are typically to corporate accounts that purchase at
volume discounts, the gross margin on such sales is generally lower than
inbound sales, although the gross profit dollar contribution per order is
generally higher as average order sizes to corporate accounts are usually
larger. The Company believes that outbound sales will continue to represent a
larger portion of its business mix in future periods.
The direct marketing of personal computers and related products is highly
competitive. In addition to other direct marketers and manufacturers who sell
direct, such as Dell Computer Corporation and Gateway 2000, Inc.,
manufacturers of PCs sold by the Company, such as Compaq and IBM, have also
announced varying plans to sell PCs directly to end users. Separately, both
Compaq and IBM have announced plans to increase their reliance on reseller
arrangements with direct marketers such as the Company as part of their own
marketing programs designed to compete more effectively with Dell and Gateway.
The Company currently believes that direct sales by Compaq and IBM will not
have a significant adverse effect upon the Company's net sales.
Most product manufacturers provide the Company with cooperative advertising
support in exchange for product coverage in the Company's catalogs. Although
the level of cooperative advertising support available to the Company from
certain manufacturers has declined, and may decline further in the future, the
overall level of cooperative advertising revenues has continued to increase
consistent with the Company's increased levels of spending for catalog and
other advertising programs. The Company believes that the overall levels of
cooperative advertising revenues available over the next twelve months will be
consistent with the Company's planned advertising programs.
In connection with the planned relocation of its headquarters facility in
the summer of 1998, the Company will incur certain one-time moving and other
costs, not expected to exceed $500,000, which will be charged to operating
costs. In connection with the Offering of the Company's Common Stock that
closed in March 1998, the Company reported certain non-recurring, non-cash
items in the quarter ended March 31, 1998. See "Initial Public Offering" and
"Pro Forma and Other Adjustments" below.
INITIAL PUBLIC OFFERING
On March 6, 1998, the Company closed on its Offering of 3,593,750 shares
(including 468,750 shares issued upon the exercise of an underwriters'
overallotment option) of Common Stock at an offering price of $17.50 per
share. Net proceeds to the Company after expenses of the Offering were
approximately $57.3 million. See "Liquidity and Capital Resources".
PRO FORMA AND OTHER ADJUSTMENTS
The pro forma income statements presented below have been determined by
applying the following pro forma and other adjustments to the Company's
historical income statements:
Pro Forma Adjustments
1. Elimination of stockholder/officer compensation in excess of aggregate
established 1998 base salaries ($150,000) for each quarter. These amounts
generally represented Company-related S Corporation tax obligations payable
by the stockholder/officers for periods prior to March 6, 1998. Effective
upon the closing of the Offering, these stock-holder/officers are being
paid annual base salaries aggregating $600,000.
2. Elimination of the historical income tax benefit/provision for all
periods presented (including elimination of the $4.2 million income tax
benefit related to the establishment of additional deferred tax assets for
future tax deductions resulting from the termination of the Company's
Subchapter S Corporation status) and establishment of a provision for
federal and state income taxes that would have been payable by the Company
if taxed under Subchapter C of the Code, assuming an effective tax rate of
39% after an adjustment for stockholder/officer compensation described in
No. 1 above.
11
Other Adjustments
1. Elimination in 1998 of an $870,000 one-time charge for stock option
compensation expense relating to the acceleration in the vesting period of
certain of the Company's stock options from seven years to four years in
connection with the Offering.
PRO FORMA INCOME STATEMENTS, AS
ADJUSTED
----------------------------------
THREE MONTHS ENDED MARCH 31,
----------------------------------
1998 1997
---------------- ----------------
% OF % OF
NET NET
AMOUNT SALES AMOUNT SALES
-------- ------ -------- ------
(AMOUNTS IN THOUSANDS, EXCEPT
PER SHARE DATA)
Net sales................................. $168,643 100.00% $122,824 100.00%
Cost of sales............................. 146,694 86.98 105,445 85.85
GROSS PROFIT............................ 21,949 13.02 17,379 14.15
Selling, general and administrative ex-
penses................................... 15,988 9.48 13,637 11.10
Additional stockholder/officer compensa-
tion..................................... -- -- 30 .03
-------- ------ -------- ------
INCOME FROM OPERATIONS.................. 5,961 3.54 3,712 3.02
Interest expense.......................... (206) (.12) (365) (.30)
Other, net................................ 86 .05 3 --
Income taxes.............................. (2,278) (1.36) (1,306) (1.06)
-------- ------ -------- ------
NET INCOME.............................. $ 3,563 2.11% $ 2,044 1.66%
======== ====== ======== ======
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THE THREE MONTHS ENDED MARCH
31, 1997
The following table sets forth the Company's percentage of net sales (in
dollars) of computer systems/memory, peripherals, software, and networking and
communications products during the periods ended March 31, 1998 and 1997:
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
--------- ---------
Computer Systems/Memory................................ 41.3% 39.3%
Peripherals............................................ 35.5 34.8
Software............................................... 15.1 17.8
Networking and Communications.......................... 8.1 8.1
--------- ---------
Total.................................................. 100.0% 100.0%
========= =========
NET SALES increased $45.8 million, or 37.3% to $168.6 million for the
quarter ended March 31, 1998 from $122.8 million for the comparable period in
1997. Growth in net sales was primarily attributable to the continued
expansion and increased productivity of the Company's outbound telemarketing
group, continued growth in average order size, an increase in the number of
catalog mailings and growth in the Company's internet catalog. Outbound sales
increased $32.9 million, or 62.8%, to $85.3 million in the three months ended
March 31,1998 from $52.4 million for the three months ended March 31, 1997.
Inbound and on-line internet sales increased $12.9 million, or 18.3%, to $83.4
million in the three months ended March 31, 1998 from $70.4 million for the
three months ended March 31, 1997. System/memory sales increased to 41.3% of
net sales in 1998 from 39.3% for the comparable period in 1997.
12
PC CONNECTION, INC.
GROSS PROFIT increased $4.6 million, or 26.3%, to $21.9 million for the
quarter ended March 31, 1998 from $17.4 million for the comparable quarter in
1997. The increase in gross profit dollars was primarily attributable to the
increase in net sales described above. Gross profit margin decreased from
14.2% in the three months ended March 31, 1997 to 13.0% for the three months
ended March 31, 1998 due primarily to increased price competition, continuing
declines in average selling prices, which tend to reduce profit margins across
most product lines, increased rate of charges to cost of sales for slow-moving
and obsolete inventory, higher systems sales, and the growth in outbound
sales, which generally carry lower gross profit margins. However, the Company
generated higher gross profit dollars per order, enabling it to leverage its
operating expenses, as described below.
The Company expects that its gross margin in the future is likely to
fluctuate and may decline from the level achieved in the first quarter of 1998
since it is dependent upon several variables including vendor support
programs, product mix, pricing strategies, market conditions and other
factors.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES, increased $3.3 million, or
24.3%, to $16.9 million for the quarter ended March 31, 1998 from $13.6
million for the comparable quarter in 1997, but decreased as a percentage of
sales from 11.1% in the three months ended March 31, 1997 to 10.0% for the
three months ended March 31, 1998. The increase in expenses was primarily
attributable to a $870,000 one-time charge for stock option compensation
expense relating to the acceleration in the vesting period of certain of the
Company's stock options from seven to four years in connection with the
offering and increases in volume-sensitive costs such as sales personnel and
credit card fees. The decrease as a percentage of net sales was primarily
attributable to improved expense control and the leveraging of selling,
general and administrative expenses over a larger sales base.
Selling, general and administrative expenses, excluding the one-time charge
for stock option compensation expense, increased $2.4 million, or 17.6%, to
$16.0 million for the quarter ended March 31, 1998 from $13.6 million for the
comparable quarter in 1997, but decreased as a percentage of sales from 11.1%
in 1997 to 9.5% in 1998.
ADDITIONAL STOCKHOLDER/OFFICER COMPENSATION was $2.4 million for the quarter
ended March 31, 1998, compared to $2.5 million for the quarter ended March 31,
1997. These amounts generally represented Company-related federal income tax
obligations payable by the stockholder/officers for periods prior to March 6,
1998. Effective upon closing of the Offering, these stockholder/officers are
being paid annual base salaries aggregating $600,000.
INCOME FROM OPERATIONS increased $1.4 million, or 107.7%, to $2.7 million
for the quarter ended March 31, 1998, from $1.3 million for the quarter ended
March 31, 1997. Income from operations as a percentage of sales increased from
1.1% in the three months ended March 31, 1997 to 1.6% in the comparable period
in 1998 for the reasons discussed above.
Income from operations, excluding both the one-time charge for stock option
compensation expense ($870,000) and the additional stockholder/officer
compensation ($2,354,000 and $2,452,000 for 1998 and 1997, respectively),
increased by $2.3 million, or 62.2%, to $6.0 million for the quarter ended
March 31, 1998 from $3.7 million for the quarter ended March 31, 1997, or 3.5%
and 3.0% of sales, respectively.
INTEREST EXPENSE decreased $159,000, or 43.6%, to $206,000 for the quarter
ended March 31, 1998 from $365,000 for the comparable quarter in 1997, due
primarily to lower average outstanding borrowings generally in the three
months ended March 31, 1998, compared to the comparable period in 1997, and
particularly, to the full payment of all outstanding bank borrowings at the
close of the Offering.
13
INCOME TAXES for three months ended March 31, 1998 was a benefit of $3.8
million compared to a provision of $130,000 for the same quarter a year ago.
Effective with the consummation of the Offering, the Company's S Corporation
election was automatically terminated and the Company recorded a tax benefit
of approximately $4.2 million relating to the establishment of additional net
deferred tax assets for future tax deductions resulting from the termination
of the S Corporation election. In addition, for the period subsequent to March
6, 1998, the Company recorded income tax expense at the Company's effective
tax rate (39%). For periods prior to the termination of the S Corporation
election, the Company was only required to pay New Hampshire Business Profits
Tax.
NET INCOME increased $5.6 million, or 700%, to $6.4 million for the quarter
ended March 31, 1998 from $800,000 for the comparable quarter in 1997,
principally as a result of the $4.2 million income tax benefit and increases
in operating income as described above.
PRO FORMA NET INCOME was $3.0 million, or $.20 per share, for the quarter
ended March 31, 1998, compared to pro forma net income of $2.0 million, or
$.14 per share for the corresponding quarter a year ago. Pro forma net income
is determined by (i) eliminating stockholder/officer compensation in excess of
quarterly base salaries ($150,000) and (ii) by eliminating the actual income
tax provision/benefit and adding a provision for federal and state income
taxes that would have been payable by the Company under Subchapter C of the
Internal Revenue Code ("Code").
Excluding a one-time charge for the acceleration of certain stock option
compensation expense (described above), the Company would have reported pro
forma net income of $3.6 million, or $.24 per share, for the quarter ended
March 31, 1998, compared to pro forma net income of $2.0 million, or $.14 per
share, for the corresponding quarter a year ago, an increase of $.10 per
share, or 71%.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations and capital
expenditures through cash flow from operations and bank borrowings. In March
1998, the Company completed an initial public offering and used the net
proceeds of the Offering, aggregating $57.3 million, to repay all outstanding
bank indebtedness of $12.9 million and to pay a dividend of $33.0 million to
its then current stockholders, equal to substantially all previously taxed,
but undistributed, S Corporation earnings of the Company. The remaining net
proceeds of $11.4 million have been invested in short-term investment
securities and are being used for general corporate purposes. The Company
believes that funds generated from operations, together with the net proceeds
from the Offering and available credit under its bank line of credit, will be
sufficient to finance its working capital and capital expenditure requirements
at least through 1998.
Net cash provided by operating activities was $26.1 million in the quarter
ended March 31, 1998, as compared to $6.7 million provided in the comparable
period in 1997. The primary factors historically affecting cash flows from
operations are the Company's net income and changes in the levels of accounts
receivable, inventories and accounts payable. Historically, inventories and
accounts payable have increased as a result of the sales growth of the
Company. Accounts receivable have increased primarily due to an increase in
open account purchases by commercial customers resulting from the Company's
continued efforts to increase its sales to such customers, offset in part by a
higher rate of increase in accounts receivable allowances for sales returns
and doubtful accounts related to the growth in sales and the
disproportionately higher level and complexity of settlement claims with
vendors.
Capital expenditures were $2.0 million in the quarter ended March 31, 1998,
as compared to $800,000 in the comparable period in 1997. The majority of the
capital expenditures for the first quarter of 1998 and 1997 relate to computer
hardware and software for the Company's management information systems. The
Company
14
has been in the process over the last year of upgrading its order management
and fulfillment systems to new hardware and software. The conversion is
expected to be completed during the third quarter of 1998. Total additional
expenditures related to the management information systems for the year ending
December 31, 1998 is estimated at $1.5 million.
In addition, in connection with the planned relocation of its headquarters
facility in the summer of 1998, the Company expects to spend approximately
$2.5 million in total for leasehold improvements and for furniture and
equipment.
As of March 31, 1998, the Company had a credit agreement with a bank
providing for short-term borrowings equal to the lesser of $45 million or an
amount determined by a formula based on accounts receivable and inventory
balances. Such borrowings are collateralized by the Company's accounts
receivable and inventories (other than inventories pledged to secure trade
credit arrangements) and bear interest at the prime rate (8.5% at March 31,
1998). The credit agreement includes various customary financial and operating
covenants, including restrictions on the payment of dividends, except for
dividends to stockholders in respect of income taxes, none of which the
Company believes significantly restricts its operations. No borrowings were
outstanding at March 31, 1998. The Company had $63.8 million in outstanding
accounts payable at March 31, 1998, including $15.2 million for in-transit
inventory from vendors not yet received by the Company but for which title
passed to the Company upon shipment. Such accounts are generally paid within
30 days of incurrence and will be financed by cash flows from operations or
short-term borrowings under the line of credit.
INFLATION
The Company has historically offset any inflation in operating costs by a
combination of increased productivity and price increases, where appropriate.
The Company does not expect inflation to have a significant impact on its
business in the future.
YEAR 2000 COMPLIANT INFORMATION SYSTEMS
The change in date from 1999 to 2000 poses potential problems for many
computer and electro-mechanical systems around the world. Some of the
Company's systems could be affected by this problem.
In order to minimize any potential disruption to the Company's business, the
Company has an active, on-going program to evaluate its systems and take
corrective action prior to the millennium change. A full-time senior manager
is responsible for managing the Year 2000 Project, which is comprised of five
phases: Awareness, Assessment, Renovation, Validation and Implementation. For
each system that is determined to be non-compliant, the Company will take one
of the following three courses of action to achieve date compliance: renovate
(convert) the current system; replace the current system with a new date
compliant system; or retire the current system because it no longer serves a
valid business need.
The Company is investigating the extent to which its systems may be affected
and communicating to all of its system vendors concerning timely and completed
remedies for those systems requiring modification. The Company currently
believes it will be able to modify or replace any affected systems in time to
minimize any detrimental effect on operations. While it is not possible, at
present, to give an accurate estimate of the cost of this work, the Company
expects that such costs will not be material to the Company's results of
operations. System maintenance or software modification costs will be expensed
as incurred, while the costs of new software (such as the new order management
and fulfillment software) will be capitalized and amortized over the
software's expected useful life.
15
The Company is also communicating with all third-parties on which it relies
to assess their progress in evaluating their systems and implementing
appropriate corrective measures. Further, the Company is actively encouraging
its customers to undertake their own Year 2000 Compliance projects in order to
insure the continued viability of the Company's commercial business pursuits.
The Company has been taking, and will continue to pursue, all reasonably
necessary steps to protect its operations, assets and the interests of its
customers, shareholders, employees and community partners.
16
PC--CONNECTION, INC.
PART I--FINANCIAL INFORMATION
ITEM 3--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable for the Company until fiscal year ending December 31, 1998.
17
PC CONNECTION, INC.
PART II--OTHER INFORMATION
ITEM 1--LEGAL PROCEEDINGS
Not Applicable
ITEM 2--CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company reincorporated in Delaware from New Hampshire in February 1998.
The Company's Amended and Restated Certificate of Incorporation filed in
Delaware authorizes the issuance of up to 30,000,000 shares of common stock,
$.01 par value per share (the "Common Stock"), and 7,500,000 shares of
preferred stock, $.01 par value (the "Preferred Stock"). Pursuant to the
reincorporation, the Company converted all of the issued and outstanding
shares of Series A Non-Voting Common Stock, $.01 par value per share, and
Series B Voting Common Stock, $.01 par value per share, of the New Hampshire
corporation into 11,798,793 shares of the Delaware corporation's Common Stock
on a one-for-one basis. Therefore, the non-voting stock of the New Hampshire
corporation was eliminated and the holders of Common Stock are entitled to one
vote for each share held on all matters submitted to a vote of stockholders.
Use of Proceeds of Initial Public Offering
On March 3, 1998, the Company commenced the initial public offering of
3,125,000 shares of Common Stock, of the Company pursuant to a Registration
Statement on Form S-1 (Commission File No. 333-41171) declared effective by
the Securities and Exchange Commission on March 2, 1998. Prior to closing the
underwriters exercised their over-allotment option to purchase an additional
468,750 shares of Common Stock of the Company.
The Offering terminated with the closing on March 6, 1998, resulting in the
sale of all 3,593,750 shares offered at an offering price of $17.50 per share
for an aggregate offering to the public of $62,890,625.
The managing underwriters of the Offering were Donaldson, Lufkin & Jenrette
Securities Corporation, NationsBanc Montgomery Securities LLC and William
Blair & Company, LLC.
Through March 6, 1998, the aggregate amount of expenses incurred by the
Company in connection with the issuance of and distribution of the shares of
Common Stock offered and sold in the Offering were approximately $5,637,713,
including $4,402,344 in underwriting discounts and commissions and $1,235,369
in other expenses. The net proceeds to the Company from the Offering after
deducting underwriting discounts and commissions and other expenses were
approximately $57,252,912.
The Company used the net proceeds from the offering for repayment of bank
indebtedness ($12.9 million), and to pay a dividend to its current
stockholders ($33.0 million) equal to substantially all previously taxed, but
undistributed, S Corporation earnings of the Company. The remaining net
proceeds ($11.4 million) have been invested in short-term investment
securities and will be used for general corporate purposes.
None of the expenses paid by the Company were paid, directly or indirectly,
to directors, officers, persons owning ten percent or more of the Company's
equity securities or affiliates of the Company. However, Martin C. Murrer, a
director of the Company, is a managing director of Donaldson, Lufkin &
Jenrette Securities Corporation.
ITEM 3--DEFAULTS UPON SENIOR SECURITIES
Not applicable.
18
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Pursuant to a Written Action of Stockholders in Lieu of Annual Meeting dated
February 17, 1998, the following matters were submitted to stockholder vote
and unanimously approved:
(a) The Amended and Restated Certificate of Incorporation and the filing
by the Company with the Secretary of State of the State of Delaware of the
Amended and Restated Certificate of Incorporation;
(b) The Agreement and Plan of Merger by and between the Company and PC
Connection, Inc., a New Hampshire corporation;
(c) The Certificate of Merger and the filing by the Company with the
Secretary of State of the State of Delaware of the Certificate of Merger;
(d) The adoption of the 1997 Stock Incentive Plan providing for the
issuance of up to an aggregate of 800,000 shares of Common Stock of the
Company;
(e) The adoption of the 1997 Employee Stock Purchase Plan providing for
the issuance of up to an aggregate of 225,000 shares of Common Stock of the
Company; and
(f) The election of Patricia Gallup, David Hall, David B. Beffa-Negrini,
Martin C. Murrer and Peter J. Baxter to serve as directors of the Company
until the 1999 Annual Meeting of Stockholders and thereafter until their
successors are duly elected and qualified.
ITEM 5--OTHER INFORMATION
Not applicable
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
27............................................... Financial Data Schedule
(b) REPORTS ON FORM 8-K
(i) None
19
PC CONNECTION, INC.
MARCH 31, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PC Connection Inc.
May 14, 1998
/s/
By:__________________________________
Wayne L. Wilson
President and Chief Operating
Officer
May 14, 1998 /s/
By:__________________________________
Mark A. Gavin
Vice President of Finance and
Chief Financial Officer
20
5
1,000
3-MOS 3-MOS
DEC-31-1998 DEC-31-1997
JAN-01-1998 JAN-01-1997
MAR-31-1998 MAR-31-1997
16,309 758
0 0
39,309 35,281
6,070 5,360
63,983 63,720
119,477 96,979
27,933 26,040
18,260 17,577
129,649 105,442
74,909 78,072
0 3,250
0 0
0 0
154 118
54,586 24,002
129,649 105,442
168,643 122,824
168,643 122,824
146,694 105,445
146,694 105,445
(86) (3)
880 471
206 365
2,617 930
(3,788) 130
6,405 800
0 0
0 0
0 0
6,405 800
.21 .15
.20 .14
BALANCE SHEET INFORMATION IS AS OF MARCH 31, 1998 AND DECEMBER 31, 1997,
WHEREAS INCOME STATEMENT INFORMATION IS FOR THE THREE MONTH PERIODS ENDED MARCH
31, 1998 AND 1997.
