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, 1999
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 02-0497006
-------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
730 MILFORD ROAD
MERRIMACK, NEW HAMPSHIRE 03054
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (603) 423-2000
--------------
Indicate by check mark (X) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of May 11, 1999 was 15,624,956.
PC CONNECTION, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE
--------------------- ----
- - - - - - - - - - - - - -------------------------------------------------------------------------
Item 1 Financial Statements:
Balance Sheets -- March 31, 1999
and December 31, 1998....................................1
Statements of Income -- Three
months ended March 31, 1999 and 1998.....................2
Statement of Changes in Stockholders' Equity -- Three
months ended March 31, 1999..............................3
Statements of Cash Flows -- Three
months ended March 31, 1999 and 1998 ....................4
Notes to Financial Statements..............................5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations......................9
Item 3 Qualitative and Quantitative Disclosures About
Market Risk ............................................16
PART II OTHER INFORMATION
-----------------
Item 1 Legal Proceedings.........................................17
Item 2 Changes in Securities and Use of Proceeds.................17
Item 3 Defaults Upon Senior Securities...........................17
Item 4 Submission of Matters to a Vote of Security Holders.......17
Item 5 Other Information.........................................17
Item 6 Exhibits and Reports on Form 8-K..........................17
SIGNATURES................................................18
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PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
BALANCE SHEETS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
MARCH 31, December 31,
1999 1998
ASSETS
Current Assets:
Cash and cash equivalents $ 8,579 $11,910
Accounts receivable, net 63,891 58,890
Inventories.merchandise 55,525 63,425
Deferred income taxes 2,146 3,181
Prepaid expenses and other current assets 4,398 4,115
------- -------
TOTAL CURRENT ASSETS 134,539 141,521
Deferred income taxes 361 314
Property and equipment, net 22,943 22,675
------- -------
TOTAL ASSETS $157,843 $164,510
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease
obligation to affiliate $ 126 $ 123
Accounts payable 68,741 77,561
Accrued expenses and other liabilities 7,519 10,069
-------- --------
Total current liabilities 76,386 87,753
Capital lease obligation to affiliate 7,049 7,081
-------- --------
TOTAL LIABILITIES 83,435 94,834
-------- --------
Stockholders' Equity:
Common stock 156 156
Additional paid-in capital 57,123 56,812
Retained earnings 17,129 12,708
-------- --------
TOTAL STOCKHOLDERS' EQUITY 74,408 69,676
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $157,843 $164,510
======== ========
========
See notes to financial statements.
-1-
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, 1999 1998
- - - - - - - - - - - - - ----------------------------- -------- -------
Net sales $224,979 $168,643
Cost of sales 197,913 146,694
-------- =------
GROSS PROFIT 27,066 21,949
Selling, general and administrative expenses 19,763 16,858
Additional stockholder/officer compensation - 2,354
-------- -------
INCOME FROM OPERATIONS 7,303 2,737
Interest expense (266) (206)
Other, net 94 86
Income tax benefit (provision) (2,710) 3,788
-------- -------
NET INCOME $ 4,421 $ 6,405
======== =======
Weighted average common shares outstanding:
Basic 15,622
========
Diluted 16,068
========
Earnings per share:
Basic $ .28
========
Diluted $ .28
========
Pro forma data:
Historical income before income taxes $ 2,617
Pro forma adjustment - stockholder/officer compensation
in excess of the aggregate base salaries 2,354
-------
Pro forma income before income taxes 4,971
Pro forma income taxes 1,938
-------
Pro forma net income $ 3,033
=======
Pro forma weighted average shares outstanding:
Basic 14,236
=======
Diluted 14,835
=======
Pro forma earnings per share:
Basic $ .21
=======
Diluted $ .20
=======
See notes to financial statements.
-2-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
COMMON STOCK ADDITIONAL RETAINED
------------
SHARES AMOUNT PAID IN CAPITAL EARNINGS TOTAL
BALANCE, DECEMBER 31, 1998 15,605 $ 156 $56,812 $12,708 $69,676
Exercise of stock options,
including income tax benefits 20 - 263 - 263
Compensation under nonstatutory
stock option agreements - - 48 - 48
Net income - - - 4,421 4,421
------ ------ ------- ------- ------
BALANCE, MARCH 31, 1999 15,625 $ 156 $57,123 $17,129 $74,408
====== ====== ======= ======= =======
See notes to financial statements.
-3-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
1999 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $4,421 $6,405
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,137 684
Deferred income taxes 1,139 (4,675)
Compensation under nonstatutory stock
option agreements 48 933
Provision for doubtful accounts 1,509 880
Loss on disposal of fixed assets 20 74
Changes in assets and liabilities:
Accounts receivable (6,510) (4,198)
Inventories 7,900 (263)
Prepaid expenses and other current assets (283) (124)
Accounts payable (8,820) 25,642
Amounts payable to stockholders - (1,185)
Accrued expenses and other liabilities (2,550) 1,948
------ ------
Net cash provided by (used for) operating activities (1,989) 26,121
------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,428) (1,968)
Proceeds from sale of property and equipment 3 -
------ ------
Net cash used for investing activities (1,425) (1,968)
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 142,420 20,796
Repayment of short-term borrowings (142,420) (49,114)
Repayment of term loan - (4,500)
Repayment of capital lease obligation to affiliate (29) -
Issuance of stock upon exercise of
nonstatutory stock options 112 -
Net proceeds from initial public offering - 57,253
Payment of dividend - (33,037)
------- -------
Net cash provided by (used for) financing
activities 83 (8,602)
------- -------
(Decrease) increase in cash and cash equivalents (3,331) 15,551
Cash and cash equivalents, beginning of period 11,910 758
------- -------
Cash and cash equivalents, end of period $ 8,579 $16,309
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 258 $ 358
Income taxes paid 268 4
See notes to financial statements
-4-
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 Annual Report on Form 10-K for
the year ended December 31, 1998 (the "10-K Report") filed with the Securities
and Exchange Commission ("SEC"). The accompanying financial statements should be
read in conjunction with the financial statements contained in the Company's 10-
K Report. 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 months ended March 31, 1999 may not be indicative of the results expected
for any succeeding quarter or the entire year ending December 31, 1999.
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 -INITIAL PUBLIC OFFERING
On March 6, 1998, the Company completed its initial public offering of 3,593,750
shares of Common Stock ("the Offering") (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 to repay 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 used for general corporate
purposes.
NOTE 4 - PRO FORMA INCOME STATEMENT DATA
The following pro forma adjustments have been made to the historical results of
operations for the three months ended March 31, 1998 to make the pro forma
presentation comparable to what would have been reported had the Company
operated as a C Corporation for that period:
1.Elimination of stockholder/officer compensation in excess of aggregate
established 1998 quarterly base salaries ($150,000) for the period prior to
March 6, 1998. 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
stockholder/officers are being paid annual base salaries aggregating
$600,000.
2.Elimination of the historical income tax benefit/provision for the period
prior to March 6, 1998 (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% for the
quarter ended March 31, 1998 after an adjustment for stockholder/officer
compensation described in No. 1 above.
-5-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS-CONTINUED
(UNAUDITED)
NOTE 5 - EARNINGS PER SHARE
Basic earnings per common share is computed using the weighted average number of
shares outstanding. Diluted earnings per common share is computed using the
weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding options to purchase common stock. The
denominator used to determine pro forma basic earnings per share for the quarter
ended March 31, 1998 includes the weighted average shares required to pay the S
Corporation dividend, assuming a price per share of $17.50.
The following table sets forth the computation of pro forma basic and diluted
earnings per share:
THREE MONTHS ENDED MARCH 31, 1999 1998
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (ACTUAL) (PRO FORMA)
Numerator:
Net income $ 4,421 $ 3,033
======== ========
Denominator:
Denominator for basic earnings per share:
Weighted average shares 15,622 12,957
Weighted average shares required to pay
stockholder dividend - 1,279
-------- --------
Denominator for pro forma basic earnings per
share 15,622 14,236
-------- --------
Effect of dilutive securities
Employee stock options 446 599
-------- --------
Denominator for pro forma diluted earnings per
share 16,068 14,835
======== ========
Pro forma earnings per share:
Basic $ .28 $ .21
========= ========
Diluted $ .28 $ .20
========= ========
The following stock options to purchase Common Stock were excluded from the
computation of diluted earnings per share for the three months ended March 31,
1999 and 1998 because the effect of the options on the calculation would have
been anti-dilutive:
THREE MONTHS ENDED
MARCH 31, (AMOUNTS IN THOUSANDS) 1999 1998
Anti-dilutive stock options 834 0
====== ======
NOTE 6 - REPORTING COMPREHENSIVE INCOME
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS 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, 1999 and 1998.
-6-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS-CONTINUED
(UNAUDITED)
NOTE 7 - RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", effective
for fiscal years beginning after June 15, 1999. The new standard requires that
all companies record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. Management is currently assessing
the impact of SFAS No. 133 on the financial statements of the Company. The
Company will adopt this accounting standard on January 1, 2000, as required.
NOTE 8 - SEGMENT AND RELATED DISCLOSURES
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information", requires that public companies report profits and losses and
certain other information on its "reportable operating segments" in its annual
and interim financial statements.
Management has determined that the Company has only one "reportable operating
segment", given the financial information provided to and used by the "chief
decision maker" of the Company to allocate and assess the Company's performance.
However, senior management does monitor revenue by platform (PC vs. Mac), sales
channel (Corporate Outbound, Inbound Telesaless and On-line Internet), and
product mix (Computer Systems and Memory, Peripherals, Software, and
Networking and Communications).
Net sales by platform, sales channel and product mix are presented below:
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
---- ----
- - - - - - - - - - - - - --------------------------------------------------------------------
Platform
--------
PC and Multi Platform $182,458 $135,856
Mac 42,521 32,787
-------- --------
Total $224,979 $168,643
======== ========
Sales Channel
-------------
Corporate Outbound $128,677 $ 85,282
Inbound Telesales 84,267 77,809
On-Line Internet 12,035 5,552
-------- --------
Total $224,979 $168,643
======== ========
Product Mix
-----------
Computer Systems and Memory $106,351 $ 69,570
Peripherals 75,646 59,887
Software 28,625 25,404
Networking and Communications 14,357 13,782
-------- --------
Total $224,979 $168,643
======== ========
-7-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE 8 - SEGMENT AND RELATED DISCLOSURES-CONT'D.
Substantially, all of the Company's net sales for the quarters ended March 31,
1999 and 1998 were made to customers located in the United States. Shipments to
customers located in foreign countries aggregated less than 2% in those
respective quarters. All of the Company's assets at March 31, 1999 and December
31, 1998 were located in the United States. The Company's primary target
customers are small- to medium-size businesses ("SMBs") comprised of 20 to 1,000
employees, although its customers also include individual consumers, larger
companies, federal, state and local governmental agencies and educational
institutions. No single customer (including the federal government) accounted
for more than 2% of total net sales in the quarters ended March 31, 1999 and
1998.
-8-
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 in Item 7 under the caption "Factors That May
Affect Future Results and Financial Condition" in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 filed with the SEC, wich are
incorporated by reference herein. 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, (ii) inbound calls from customers responding to the
Company's catalogs and other advertising and (iii)commencing in 1997, 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 23.0% of net sales for the year ended December 31, 1996 to 18.9%
of net sales in the quarter ended March 31, 1999. Although net sales
attributable to Mac products increased in the quarter ended March 31, 1999, as
compared to the comparable period in 1998, the Company believes that such sales
will continue to decrease as a percentage of net sales and may decline in dollar
volume in future periods.
All of the Company's product categories experienced strong growth in the quarter
ended March 31, 1999 over the comparable period in 1998, with sales of computer
systems representing one of the fastest growing categories. 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 $522 in the quarter ended
March 31, 1998 to $628 in the quarter ended March 31, 1999. Computer system
sales generally provide the largest gross profit dollar contribution per order
of all of the Company's products, although they usually 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 generally increased due to the leveraging of selling, general and
administrative expenses over a larger sales base.
The Company's profit margins are also influenced by, among other things,
industry pricing and the relative mix of inbound, outbound, and on-line Internet
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.
However, the gross profit dollar contribution per order is generally higher as
average order sizes of orders to corporate accounts are usually larger. The
Company believes that outbound and on-line Internet sales will continue to
represent a larger portion of its business mix in future periods.
-9-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
GENERAL - CONT'D.
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 ("Dell") and Gateway, Inc.
("Gateway"), 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,
however, 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH THE THREE MONTHS ENDED MARCH 31,
1998
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, 1999 and 1998:
THREE MONTHS ENDED MARCH 31, 1999 1998
- - - - - - - - - - - - - -------------------------------------------------------------------------
Computer Systems/Memory 47.3% 41.3%
Peripherals 33.6 35.5
Software 12.7 15.1
Networking and Communications 6.4 8.1
----- -----
Total 100.0% 100.0%
===== =====
NET SALES increased $56.3 million, or 33.4%, to $225.0 million for the quarter
ended March 31, 1999 from $168.6 million for the comparable period in 1998.
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 sales. Outbound sales increased $43.4 million,
or 50.9%, to $128.7 million in the three months ended March 31, 1999 from $85.3
million in the three months ended March 31, 1998. Inbound and on-line Internet
sales increased $12.9 million, or 15.5%, to $96.3 million in the three months
ended March 31, 1999 from $83.4 million in the three months ended March 31,
1998. Computer system/memory sales increased to 47.3% of net sales for the
three months ended March 31, 1999 from 41.3% for the comparable period in 1998.
GROSS PROFIT increased $5.1 million, or 23.3%, to $27.1 million for the quarter
ended March 31, 1999 from $21.9 million for the comparable quarter in 1998. The
increase in gross profit dollars was primarily attributable to the increase in
net sales described above. Gross profit margin decreased from 13.0% for the
three months ended March 31, 1998 to 12.0% for the three months ended March 31,
1999, due primarily to the continued decline in margins for system sales and
growth in outbound telemarketing sales, which generally carry lower margins.
During 1999, certain product manufacturers changed the focus of their vendor
support programs from providing general cooperative advertising dollars to
issuing rebates based on specified product sell through. The effect of this
change in vendor focus impacted both cost of sales and selling, general and
administrative expenses, because rebates are accounted for as credits to cost of
sales and cooperative advertising revenue is credited to advertising expense.
The Company anticipates that this trend may continue in the future.
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 1999 since it is
dependent upon several variables including vendor support programs, product mix,
pricing strategies, market conditions and other factors.
-10-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS - GENERAL - CONT'D.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased $2.9 million, or 17.2%,
to $19.8 million for the quarter ended March 31, 1999 from $16.9 million for the
comparable quarter in 1998, but decreased as a percentage of sales from 10.0% in
the three months ended March 31, 1998 to 8.8% for the three months ended March
31, 1999. The increase in expenses was primarily attributable to increases in
volume-sensitive costs such as sales personnel and credit card fees. However,
the 1998 quarter included 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. Selling, general and administrative expenses, excluding the
one-time charge in 1998 for stock option compensation expense, increased $3.8
million, or 23.6%, in the quarter ended March 31, 1999 over the comparable
period in 1998, but decreased as a percentage of sales from 9.5% for the three
months ended March 31, 1998 to 8.8% for the comparable period in 1999. The
decrease as a percentage of net sales was primarily attributable to the
leveraging of selling, general and administrative expenses over a larger sales
base.
ADDITIONAL STOCKHOLDER/OFFICER COMPENSATION was $0 for the three months ended
March 31, 1999, compared to $2.4 million for the comparable period in 1998.
This amount generally represented Company-related S Corporation income tax
obligations payable by the stockholder/officers for periods prior to March 6,
1998. Effective upon closing of the Offering, the stockholder/officers are being
paid annual base salaries aggregating $600,000.
INCOME FROM OPERATIONS increased $4.6 million, or 166.8%, to $7.3 million for
the quarter ended March 31, 1999, from $2.7 million for the quarter ended March
31, 1998. Income from operations as a percentage of sales increased from 1.6% in
the three months ended March 31, 1998 to 3.3% in the comparable period in 1999
for the reasons discussed above.Income from operations, excluding both the
1998 one-time charge for stock option compensation expense ($870,000) and
the additional 1998 stockholder/officer compensation in excess of their
aggregate quarterly base salaries of $150,000 ($2.4 million), increased by
$1.3 million, or 22.5%, for the quarter ended March 31, 1999. Such income
from operations as a percentage of net sales changed from 3.5% for the
three month period ended March 31, 1998 to 3.3% for the comparable
period in 1999.
INTEREST EXPENSE increased $60,000, or 29.1%, to $266,000 in the three months
ended March 31, 1999 from $206,000 for the comparable period in 1998. This
increase in interest expense was due primarily to the interest recognized on the
capital lease of the Company's new headquarters facility which began in December
1998, offset in part by generally lower average outstanding bank borrowings in
the three months ended March 31, 1999, compared to the comparable period in
1998.
INCOME TAXES for the three months ended March 31, 1999 was a tax provision
of $2.7 million compared to a pro forma tax provision of $1.9 million for
the comparable quarter in 1998. The effective tax rate was 38% for the
three months ended March 31, 1999, compared to the pro forma effective tax
rate of 39% for the three months ended March 31, 1998.
-11-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS - GENERAL - CONT'D.
NET INCOME for the quarter ended March 31, 1999 decreased $2.0 million, or
31.0%, to $4.4 million from $6.4 million for the comparable quarter in 1998,
principally as a result of a net $3.8 million income tax benefit in 1998, offset
in part by the increases in operating income.
PRO FORMA NET INCOME calculated for the three months ended March 31, 1998, 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"). Net income for the quarter ended March 31, 1999 was $4.4
million, or $.28 per share, compared to pro forma net income for the quarter
ended March 31, 1998 of $3.0 million, or $.20 per share.
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
were 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 1999. The Company's ability to
continue funding its planned growth is dependent upon its ability to generate
sufficient cash flow from operations or to obtain additional funds through
equity or debt financing, or from other sources of financing, as may be
required.
Net cash used by operating activities was $2.0 million for the three months
ended March 31, 1999, as compared to $26.1 million provided in the comparable
period in 1998. 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. 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. Historically, inventories and accounts payable have increased as a
result of the sales growth of the Company; however, inventory and accounts
payable decreased in the three months ended March 31, 1999 by $7.9 million and
$8.8 million, respectively, compared to relatively little change in inventory
and an increase in accounts payable of $25.6 million in the comparable
period in 1998, principally related to the timing of payments and steps
taken to improve inventory turns.
At March 31, 1999, the Company had cash and cash equivalents of $8.6 million and
working capital of $58.2 million. At December 31, 1998, the Company had cash and
cash equivalents of $11.9 million and working capital of $53.8 million.
Capital expenditures were $1.4 million in the three months ended March 31, 1999,
as compared to $2.0 million in the comparable period in 1998. The majority of
the capital expenditures for the respective 1999 and 1998 periods relate to
computer hardware and software for the Company's management information
systems. The Company has been in the process over the last year of upgrading
its order management and fulfillment systems to new hardware and software.
The conversion was completed during the third quarter of 1998. Total
capital expenditures for the year ending December 31, 1999 are estimated at
$10.0 million.
-12-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES - CONT'D.
The Company has 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. Borrowing
availability at March 31, 1999 was $45 million. 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 (7.75% at March 31, 1999). 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, 1999.
The Company had $68.7 million in outstanding accounts payable at March 31, 1999,
including $4.0 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.
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 which could have a material adverse effect on
the Company's business, financial condition and results of operations.
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 is taking one of
the following three courses of action to achieve date compliance: (i) renovate
(convert) the current system; (ii) replace the current system with a new date
compliant system; or (iii) retire the current system because it no longer
serves a valid business need.
The Company recently replaced its order management and fulfillment software with
new software and converted its principal computer equipment to new IBM AS400
platform systems, both of which are better suited to the Company's expected
scale of operations and are designed to be Year 2000 compliant. The Company is
investigating the extent to which its other 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.
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, and such assessments are expected to be completed by
June 30, 1999. Furthermore, the Company is actively encouraging its
customers to undertake their own Year 2000 compliance projects in order to
ensure 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.
Utilizing both internal and external resources to identify and assess needed
Year 2000 remediation, the Company currently anticipates that its Year 2000
awareness, assessment, renovation and validation efforts, which began in 1996,
will be completed by June 30, 1999, and that such efforts will be completed
prior to any currently anticipated impact on its computer equipment and
software. The Company estimates that as of March 31, 1999, it had completed
approximately 90% of the initiatives that it believes will be necessary to fully
address potential Year 2000 issues relating to its computer equipment and
software. The majority of the projects comprising the remaining 10% of the
initiatives are in process and expected to be substantially completed by June
30, 1999.
-13-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
YEAR 2000 COMPLIANT INFORMATION SYSTEMS- CONT'D.
TIME PERCENT
FRAME COMPLETED
----- ---------
- - - - - - - - - - - - - --------------------------------------------------------------------------
Status of overall Year 2000 Project:
Awareness 10/97 - 06/98 100%
Assessment 10/97 - 12/98 100%
Renovation 04/98 - 09/99 90%
Validation 05/98 - 11/99 75%
Implementation 05/98 - 12/99 80%
Summary of significant Year 2000 projects completed:
Conversion to new IBM AS400 10/96 - 09/98 100%
Conversion to new order management and
fulfillment software 10/96 - 09/98 100%
The primary objectives of the Year 2000 Project relating to the Company's
internal systems were met when the Company implemented its new order management
and fulfillment software and upgraded its IBM AS400 data processing platform.
The majority of the costs (approximately $5.5 million) of the new software and
hardware were capitalized during the period October 1, 1997 to September 30,
1998. The Company believes that the costs of its Year 2000 awareness,
assessment, renovation, validation and implementation for all other computer
equipment and software, as well as currently anticipated costs to be incurred by
the Company with respect to Year 2000 issues of third parties, will not exceed
$500,000, which will be funded from operating cash flow. These costs will be
expensed as incurred and funded from working capital.
The Company presently believes that the Year 2000 issue will not pose
significant operational problems for the Company. However, for all Year 2000
issues that are not properly identified, or assessments, renovation, validation
and implementation are not effected timely with respect to Year 2000 problems,
there can be no assurance that the Year 2000 issues of other entities will not
have a material adverse impact on the Company's systems or results of
operations.
The Company is presently undertaking, a comprehensive analysis of the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with worst
case scenarios, and such scenarios have not yet been clearly identified. The
Company currently plans to complete such analysis and contingency planning
before December 31, 1999.
The costs of the Company's Year 2000 awareness, assessment, renovation,
validation and implementation efforts and the dates on which the Company
believes it will complete such efforts are based upon management's best
estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
remediation plans, and other factors. There can be no assurance that these
estimates will prove to be accurate and actual results could differ materially
from those currently anticipated. Specific factors that could cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in Year 2000 issues, the ability to assess, renovate and
implement all relevant computer codes and embedded technology and similar
uncertainties. In addition, variability of definitions of "Year 2000 Compliance"
and the myriad of different products and services and combinations thereof, sold
by the Company may lead to claims whose impact on the Company is not currently
estimable. No assurance can be given that the aggregate cost of defending and
resolving such claims, if any, will not materially adversely affect the
Company's results of operations. Although some of the Company's agreements with
manufacturers and others from whom it purchases products for resale contain
provisions requiring such parties to indemnify the Company under some
circumstances, there can be no assurance that such indemnification arrangements
will cover all of the Company's liabilities and costs related to claims by third
parties related to the Year 2000 issue.
-14-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. The new standard requires that all companies record derivatives
on the balance sheet as assets or liabilities, measured at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. Management is currently assessing the impact of SFAS No.
133 on the financial statements of the Company. The Company will adopt this
accounting standard on January 1, 2000, as required.
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.
-15-
PC CONNECTION, INC.
PART I - FINANCIAL INFORMATION
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests cash balances in excess of operating requirements in short-
term securities, generally with maturities of 90 days or less. The Company
believes that the effect, if any, of reasonably possible near-term changes in
interest rates on the Company's financial position, results of operations and
cash flows should not be material.
-16-
PC CONNECTION, INC.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Not applicable
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5 - OTHER INFORMATION
Not applicable
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
--------
Exhibit
Number Description
------ -----------
27 Financial Data Schedule
99.1 Pages 23 through 27 of the Company's Annual Report
on Form 10-K for the year ended December 31, 1998
as filed with the SEC (which is not deemed filed
except to the extent that portions thereof are
expressly incorporated by reference herein).
(b) REPORTS ON FORM 8-K
-------------------
(i) None
-17-
PC CONNECTION, INC.
MARCH 31, 1999
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, 1999 By: /s/
---------------------------------
Wayne L. Wilson
President and Chief Operating Officer
May 14, 1999 By: /s/
---------------------------------
Mark A. Gavin
Vice President of Finance
and Chief Financial Officer
5
1,000
3-MOS
DEC-31-1999
JAN-01-1999
MAR-31-1999
8,579
0
71,170
7,279
55,525
134,539
44,257
21,314
157,843
76,386
7,049
0
0
156
74,252
157,843
224,979
224,979
197,913
197,913
(94)
858
266
7,131
2,710
4,421
0
0
0
4,421
.28
.28
EXHIBIT 99.1
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
The Company's future results and financial condition are dependent on the
Company's ability to continue to successfully market, sell, and distribute
computers, hardware and software.Inherent in this process are a number of
factors that the Company must successfully manage in order to achieve
favorable operating results and financial condition. Potential risks and
uncertainties that could affect the Company's future operating results and
financial condition include, without limitation, the factors discussed below:
No Assurance of Future Growth
- - - - - - - - - - - - - -----------------------------
Net sales have grown from $196.7 million for the year ended December 31, 1994 to
$732.4 million for the year ended December 31, 1998. This growth has placed
increasing demands on the Company's management resources and facilities. The
Company's business strategy is to pursue additional growth and expand its
customer base, which is likely to result in additional demands on the Company's
resources. The Company's future success will depend in part on the ability of
the Company to manage any future growth effectively. There can be no assurance
that the Company will realize future growth in net sales or will not experience
decreases in net sales.
Risks Related to Transition or Expansion of Facilities
- - - - - - - - - - - - - ------------------------------------------------------
Additional and/or alternative facilities for distribution and sales may be
required to support significant future growth in the Company's net sales, if
realized. There can be no assurance that suitable facilities will be available,
and in the absence of such facilities, future growth could be impaired.
Dependence on Management Information Systems
- - - - - - - - - - - - - --------------------------------------------
The Company's success is dependent on the accuracy, reliability and proper use
of its management information systems, including its telephone system, and the
information generated by its management information systems. The Company does
not currently have redundant systems for all functions performed by its
management information systems or a redundant or back-up telephone system. Any
interruption in these systems or in telephone service could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
Rapid Technological Change and Exposure to Inventory Obsolescence
- - - - - - - - - - - - - -----------------------------------------------------------------
The market for personal computer products is characterized by rapid
technological change and the frequent introduction of new products and product
enhancements. The Company's success depends in part on its ability to identify
and market products that meet the needs of the marketplace. In order to satisfy
customer demand and to obtain favorable purchasing discounts, the Company may
carry increased inventory levels of certain products in the future, which will
subject it to increased risk of inventory obsolescence. In the implementation of
its business strategy, the Company intends, among other things, to place larger
than typical inventory stocking orders, increase its participation in first-to-
market purchase opportunities, and may in the future participate in end-of-life-
cycle purchase opportunities and market products on a private-label basis, all
of which will further increase the risk of inventory obsolescence. Special
purchase products are sometimes acquired without return privileges and there can
be no assurance that the Company will be able to avoid losses related to
obsolete inventory. In addition, some manufacturers provide the Company with co-
op advertising support in the form of products, for which there may be no return
privileges. Finally, certain build-to-order programs currently being implemented
by some computer systems manufacturers will likely include reductions in the
levels of price protection and product returns made available by such
manufacturers. See ''Business_ Products and Merchandising.''
Availability and Allocation of Goods
- - - - - - - - - - - - - ------------------------------------
The Company acquires products for resale from manufacturers as well as from
distributors. Purchases of products from the five vendors supplying the greatest
amount of goods to the Company constituted 44.5% and 46.5% of the Company's
total product purchases in the years ended December 31, 1998 and 1997,
respectively. Among these five vendors, purchases from Ingram Micro, Inc.
(''Ingram Micro'') represented 20.3% and 28.0% of the Company's total product
purchases in the years ended December 31, 1998 and 1997, respectively. No other
vendor supplied more than 10% of the Company's total product purchases in the
year ended December 31, 1998. The loss of Ingram Micro could cause a short-term
disruption in the availability of products and could have a material adverse
effect on the Company's financial position, results of operations and cash
flows.
Substantially all of the Company's contracts and arrangements with its vendors
that supply significant quantities of products are terminable by such vendors or
the Company without notice or upon short notice. Most of the Company's product
vendors provide the Company with trade credit, of which the net amount
outstanding at December 31, 1998 was $72.2 million. Termination, interruption or
contraction of the Company's relationships with its vendors, including a
reduction in the level of trade credit provided to the Company, could have a
material adverse effect on the Company's financial position, results of
operations and cash flows. See ''Business_ Purchasing and Vendor Relations.''
Certain product manufacturers either do not permit the Company to sell the full
line of their products or limit the number of product units available to direct
marketers such as the Company. An element of the Company's business strategy is
to increase its participation in first-to-market purchase opportunities. In the
past, availability of certain desired products, especially in the direct
marketing channel, has been constrained. The inability to source first-to-market
purchase or similar opportunities, or the reemergence of significant
availability constraints, could have a material adverse effect on the Company's
financial position, results of operations and cash flows.
Reliance on Vendor Support and Relationships
- - - - - - - - - - - - - --------------------------------------------
Some product manufacturers and distributors provide the Company with substantial
incentives in the form of payment discounts, supplier reimbursements, price
protection and rebates. No assurance can be given that the Company will continue
to receive such incentives in the future or that it will be able to collect
outstanding amounts relating to any future incentives in a timely manner or at
all.
Most product manufacturers provide the Company with co-op advertising support in
exchange for product coverage in the Company's catalogs. This support
significantly defrays the expense of catalog production. The level of co-op
advertising support available to the Company from certain manufacturers has
declined. The level of support from some manufacturers may further decline in
the future. Such a decline could increase the Company's selling, general and
administrative expenses as a percentage of sales and have a material adverse
effect on the Company's financial position, results of operations and cash
flows. See ''Business_ Purchasing and Vendor Relations.''
Competitive Risks
- - - - - - - - - - - - - -----------------
The Company competes with national and international direct marketers; product
manufacturers that sell directly to end users; specialty personal computer
retailers; personal computer and general merchandise superstores; consumer
electronic and office supply stores; and shopping services on television, the
Internet and commercial on-line networks. The Company competes not only for
customers, but also for co-op advertising support from personal computer product
manufacturers. Some of the Company's competitors are larger and have
substantially greater financial resources, superior operating results, and
larger catalog circulations and customer bases than the Company. In addition,
several direct marketers have recently been acquired by larger competitors. This
industry consolidation could result in short-term price-cutting in certain
markets. There can be no assurance that the Company will be able to compete
effectively with existing competitors or any new competitors that may enter the
market, or that the Company's financial position, results of operations and cash
flows will not be adversely affected by intensified competition. See
''Business - Competition.''
Pricing Risks
- - - - - - - - - - - - - -------------
The personal computer industry has experienced intense price competition. The
Company believes that price competition may increase in the future and that such
competition could result in a reduction of the Company's profit margins. Also,
the Company has recently increased its sales of personal computer hardware
products that generally produce lower profit margins than those associated with
software products. Significant margin decreases could have a material adverse
effect on the Company's financial position, results of operations and cash
flows.
Economic Risks
- - - - - - - - - - - - - --------------
The market for personal computers and related products has grown rapidly in
recent years. Recent statements by industry observers have indicated that there
may be a slowdown in the growth rate of the personal computing industry. If the
growth of this market or the direct marketing channel were to cease or decrease,
the Company's financial position, results of operations and cash flows would be
materially adversely affected. Demand for many of the products carried by the
Company may be subject to economic cycles. The Company's business and growth
could be affected by the spending patterns of existing or prospective customers,
a recession or prolonged economic slowdown, the cyclical nature of capital
expenditures of businesses, continued competition and pricing pressures and
other trends in the general economy, any one of which could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
Dependence on Third Party Shippers
- - - - - - - - - - - - - ----------------------------------
The Company ships approximately 75% of its products to customers by Airborne
Freight Corporation D/B/A ''Airborne Express'' (''Airborne Express''), with the
remainder being shipped by United Parcel Service of America, Inc. and other
overnight delivery and surface services. Strikes or other service interruptions
by such shippers could adversely affect the Company's ability to market or
deliver product on a timely basis and have a material adverse effect on the
Company's financial position, results of operations and cash flows. See
''Business - Distribution.''
Potential Increases in Shipping, Paper and Postage Costs
- - - - - - - - - - - - - --------------------------------------------------------
Shipping costs are a significant expense in the operation of the Company's
business. The Company has a long-term contract with Airborne Express for
shipment of its products under which the Company believes it has negotiated
favorable shipping rates. The Company generally invoices customers for shipping
and handling charges. There can be no assurance that the full cost, including
any future increases in the cost, of commercial delivery services can be passed
on to the Company's customers, which could have a material adverse effect on the
Company's financial position, results of operations and cash flows. In addition,
the current shipping rates under the Airborne Express contract are subject to
renegotiation in 1999, and there can be no assurance that such renegotiated
rates will continue to be as favorable to the Company, which could have a
material adverse effect on the Company's financial position, results of
operations and cash flows. See ''Business - Distribution'' and ''Business -
Marketing and Sales.''
The Company also incurs substantial paper and postage costs related to its
marketing activities, including its catalog production and mailings. Any
increases in postal or paper costs could have a material adverse effect on the
Company's financial position, results of operations and cash flows.
No Assurance of Future Profitability; Variability of Quarterly Results
- - - - - - - - - - - - - ----------------------------------------------------------------------
The Company has experienced significant fluctuations in its operating results,
and these fluctuations may continue in the future. The Company incurred net
losses in the year ended December 31, 1994. The Company's results of operations
are significantly affected by many factors, including seasonal and other
fluctuations in demand for personal computer products and in profit margins on
products sold, catalog timing and circulation, product availability, and timing
of releases of new and upgraded products. Many of these factors are outside the
control of the Company. The Company's operating results are heavily dependent
upon its ability to predict sales levels, monitor and control associated
expenses, and carefully manage all aspects of its operations, including product
selection and pricing, purchasing and payables practices, inventory management,
and catalog funding, production and circulation. If revenues do not meet
expectations in any given quarter, or if the Company experiences difficulty in
monitoring or controlling associated expenses, the Company's financial position,
results of operations and cash flows may be materially adversely affected. There
can be no assurance that the Company will be profitable on a quarterly or annual
basis. It is possible that in some future quarter the expectations of public
market analysts and investors will exceed the Company's operating results. In
such event, the price of the Common Stock would likely be materially adversely
affected. See "Selected Quarterly Financial Results" within this section.
Changing Methods of Distribution
- - - - - - - - - - - - - --------------------------------
The manner in which personal computers and related products are distributed and
sold is changing, and new methods of distribution and sale, such as on-line
shopping services, have emerged. Hardware and software manufacturers have sold,
and may intensify their efforts to sell, their products directly to end users.
From time to time, certain manufacturers have instituted programs for the direct
sales of large order quantities of hardware and software to certain major
corporate accounts. These types of programs may continue to be developed and
used by various manufacturers. Certain of the Company's vendors, including
Apple, Compaq and IBM, currently sell some of their products directly to end
users. In addition, manufacturers may attempt to increase the volume of software
products distributed electronically to end users. An increase in the volume of
products sold through or used by consumers of any of these competitive programs
or distributed electronically to end users could have a material adverse effect
on the Company's financial position, results of operations and cash flows.
State Sales or Use Tax Collection Uncertainties
- - - - - - - - - - - - - -----------------------------------------------
The Company presently collects sales tax only on sales of products to residents
of the State of Ohio. Sales to customers located within the State of Ohio were
less than 2% of the Company's net sales during the year ended December 31, 1998.
Various states have sought to impose on direct marketers the burden of
collecting state sales taxes on the sales of products shipped to their
residents. In 1992, the United States Supreme Court affirmed its position that
it is unconstitutional for a state to impose sales or use tax collection
obligations on an out-of-state mail order company whose only contacts with the
state are limited to the distribution of catalogs and other advertising
materials through the mail and the subsequent delivery of purchased goods by
United States mail or by interstate common carrier. However, legislation that
would expand the ability of states to impose sales tax collection obligations on
direct marketers has been introduced in Congress on many occasions. Due to its
presence on various forms of electronic media and other factors, the Company's
contact with many states may exceed the contact involved in the Supreme Court
case. The Company cannot predict the level of contact that is sufficient to
permit a state to impose on the Company a sales tax collection obligation. If
the Supreme Court changes its position or if legislation is passed to overturn
the Supreme Court's decision, the imposition of a sales or use tax collection
obligation on the Company in states to which it ships products would result in
additional administrative expenses to the Company, could result in price
increases to the customer, and could reduce demand for the Company's products or
could otherwise have a material adverse effect on the Company's financial
position, results of operations and cash flows.
Dependence on Key Personnel
- - - - - - - - - - - - - ---------------------------
The Company's future performance will depend to a significant extent upon the
efforts and abilities of its senior executives. The competition for qualified
management personnel in the personal computer products industry is very intense,
and the loss of service of one or more of these persons could have an adverse
effect on the Company's business. The Company's success and plans for future
growth will also depend on its ability to hire, train and retain skilled
personnel in all areas of its business, including account managers and technical
support personnel. There can be no assurance that the Company will be able to
attract, train and retain sufficient qualified personnel to achieve its business
objectives.
Control by Principal Stockholders
- - - - - - - - - - - - - ---------------------------------
Patricia Gallup and David Hall, the principal stockholders of the Company,
beneficially own or control, in the aggregate, approximately 75% of the
outstanding shares of Common Stock. Because of their beneficial stock ownership,
these stockholders can continue to elect the members of the Board of Directors
and decide all matters requiring stockholder approval at a meeting or by a
written consent in lieu of a meeting. Similarly, such stockholders can (i)
control decisions to adopt, amend or repeal the Restated Certificate and the
Company's Bylaws, or take other actions requiring the vote or consent of the
Company's stockholders and (ii) prevent a takeover of the Company by one or more
third parties, or sell or otherwise transfer their stock to a third party, which
could deprive the Company's stockholders of a control premium that might
otherwise be realized by them in connection with an acquisition of the Company.
Such control may result in decisions that are not in the best interest of the
public stockholders of the Company. In connection with the Offering, the
principal stockholders placed all except 40,000 of the shares of Common Stock of
the Company that they beneficially own into a voting trust, pursuant to which
they are required to agree as to the manner of voting such shares in order for
the shares to be voted. Such provisions could discourage bids for the shares of
Common Stock at a premium as well as have a negative impact on the market price
of the shares of Common Stock.
