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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-K/A
Amendment No. 3
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND
EXCHANGE COMMISSION
Commission File Number 0-23827
PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
Delaware 02-0497006
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Rt. 101A, 730 Milford Road
Merrimack, New Hampshire. 03054
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(Address of principal executive offices) (Zip Code)
(603) 423-2000
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Registrant's telephone number, including area code
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value
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 X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting stock held by non-
affiliates of the Registrant, based upon the closing price of the Registrant's
Common Stock as reported on the NASDAQ National Market on March 27, 2000, was
$96,008,036. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for the purposes of this
calculation, this classification is not to be interpreted as an admission of
such status.
The number of outstanding shares of the Registrant's Common Stock on March 27,
2000 was 15,794,298.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2000 Annual Meeting of
Shareholders for the fiscal year ended December 31, 1999, which is to be filed
within 120 days of the end of the Company's fiscal year, are incorporated by
reference into Part III of this Form 10-K. The incorporation by reference herein
of portions of the Proxy Statement shall not be deemed to specifically
incorporate by reference the information referred to in Item 402(a) (8) of
Regulation S-K.
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This amendment deletes Items 6, 7, 7A, and 8 of Part II and Item 14 of Part
IV of the Annual Report on Form 10-K as previously filed and substitutes in lieu
thereof the information set forth below.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this Amendment No. 3 on
Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly
authorized.
PC Connection, Inc.
Date: August 1, 2000 By: /s/ Patricia Gallup
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Patricia Gallup, Chairman and CEO
PART II
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Item 6. Selected Financial and Operating Data
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The following selected financial and operating data should be read in
conjunction with the Company's Consolidated Financial Statements and the Notes
thereto, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere herein. The selected data presented
below under the captions "Statement of Operations Data" and "Balance Sheet Data"
for each of the years in the five-year period ended December 31, 1999 are
derived from the audited financial statements of the Company. The Company's
consolidated financial statements as of December 31, 1999 and 1998 and for each
of the years in the three-year period ended December 31, 1999 and the
independent auditors' report thereon, are included elsewhere herein.
Year Ended December 31,
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1999 1998 1997 1996 1995
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(dollars in thousands, except per share and selected operating data)
Statement Of Operations Data:
Net sales $ 1,056,704 $ 732,370 $ 550,575 $ 333,322 $ 252,217
Cost of sales 927,358 639,096 474,609 282,117 211,299
----------- ----------- ----------- ----------- -----------
Gross profit 129,346 93,274 75,966 51,205 40,918
Selling, general and administrative expenses 91,405 68,521 56,596 43,739 38,373
Additional stockholder/officer compensation/(1)/ - 2,354 12,130 1,259 -
----------- ----------- ----------- ----------- -----------
Income from operations 37,941 22,399 7,240 6,207 2,545
Interest expense (1,392) (415) (1,355) (1,269) (1,296)
Other, net 116 565 (42) 70 62
----------- ----------- ----------- ----------- -----------
Income before income taxes 36,665 22,549 5,843 5,008 1,311
Income tax provision/(2)/ (13,935) (3,905) (639) (252) (38)
----------- ----------- ----------- ----------- -----------
Net income $ 22,730 $ 18,644 $ 5,204 $ 4,756 $ 1,273
=========== =========== =========== =========== ===========
Pro Forma Data/(3)/
Basic net income per share $ 1.45 $ .91 $ .26
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Diluted net income per share $ 1.41 $ .88 $ .25
=========== =========== ===========
Selected Operating Data:
Active customers/(4)/ 732,000 684,000 510,000 424,000 353,000
Catalogs distributed 47,325,000 42,150,000 33,800,000 18,600,000 16,800,000
Orders entered/(5)/ 1,622,000 1,510,000 1,252,000 910,000 854,000
Average order size/(5)/ $ 781 $ 580 $ 524 $ 453 $ 346
December 31,
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1999 1998 1997 1996 1995
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(dollars in thousands)
Balance Sheet Data:
Working capital $ 72,250 $ 53,768 $ 18,907 $ 14,622 $ 10,994
Total assets 223,537 164,510 105,442 77,358 49,661
Short-term debt 1,137 123 29,568 13,057 4,933
Long-term debt (less current maturities):
Capital lease obligations 6,945 7,081 - - -
Term loan - - 3,250 4,250 5,000
Note payable 2,000 - - - -
Total stockholders' equity 94,223 69,676 24,120 18,043 13,057
-1-
/(1)/ Represents amounts accrued or distributed in excess of aggregate annual
base salaries approved by the Board of Directors and generally represents
Company-related federal income tax obligations payable by the
stockholders.
/(2)/ For all periods prior to March 6, 1998, the Company had been an S
Corporation and, accordingly, had not been subject to federal income
taxes.
/(3)/ 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 1998 and 1997:
(i) Computation of income tax expense assuming an effective tax rate of
approximately 39%. (See Note 9 to the financial statements.)
/(4)/ Represents estimates of all customers included in the Company's mailing
list who have made a purchase within the last twelve month period.
/(5)/ Does not reflect cancellations or returns.
-2-
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's
consolidated financial statements.
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 industry in which the
Company operates, 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" 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
"Factors That May Affect Future Results and Financial Condition" included within
this section. Particular attention should be paid to the cautionary statements
involving the industry's rapid technological change and exposure to inventory
obsolescence, availability and allocations of goods, reliance on vendor support
and relationships, 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. 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 selected computer industry publications 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) the Company's Internet
Web site.
The Company offers both PC compatible products and Mac compatible products.
Reliance on Mac product sales has decreased over the last three years, from
23.0% of net sales in 1996 to 15.3% of net sales for the year ended December 31,
1999. The Company believes that sales attributable to Mac products will continue
to decrease as a percentage of net sales and may decline in dollar volume in
2000 and future years.
All of the Company's product categories experienced strong growth in the year
ended December 31, 1999 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 $453 in the year ended December 31, 1996 to $781 in the year ended December
31, 1999. Computer system sales generally provide the largest gross profit
dollar contribution per order of all of the Company's products, although they
generally yield the lowest gross margin percentage. Partially as a result of
higher system sales, the Company's gross margin percentage has declined over the
last few years while the operating income margin has 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 versus 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.
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 sales will continue to represent a larger portion
of its business mix in future periods.
-3-
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 Apple, Compaq and
IBM, have also announced varying plans to sell PCs directly to end users. 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 co-op advertising support in
exchange for product coverage in the Company's catalogs. Although the level of
co-op advertising support available to the Company from certain manufacturers
has declined, and may decline further in the future, the overall level of co-op
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 co-op advertising revenues available
over the next twelve months will be consistent with the Company's planned
advertising programs.
Results of Operations
The following table sets forth for the periods indicated information derived
from the Company's statements of income expressed as a percentage of net sales.
Year Ended December 31,
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1999 1998 1997
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Net sales (in millions) $1,056.7 $ 732.4 $ 550.6
======== ======== ========
Net sales 100.0% 100.0% 100.0%
Gross profit 12.2 12.7 13.8
Selling, general and administrative expenses 8.6 9.4 10.3
Additional stockholder/officer compensation 0.0 0.3 2.2
Income from operations 3.6 3.1 1.3
Interest expense (0.1) (0.0) (0.2)
Income before income taxes 3.5 3.1 1.0
Income taxes 1.3 (0.5) (0.1)
Net income 2.2 2.6 0.9
Pro forma net income 1.9 0.6
The following table sets forth the Company's percentage of net sales by
platform, sales channel, and product mix:
Year Ended December 31,
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1999 1998 1997
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Platform
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PC and Multi Platform 85% 80% 80%
Mac 15 20 20
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Total 100% 100% 100%
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Sales Channel
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Corporate Outbound 66% 53% 47%
Inbound Telesales 29 43 52
On-Line Internet 5 4 1
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Total 100% 100% 100%
==== ==== ====
Product Mix
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Computer Systems and Memory 48% 44% 42%
Peripherals 34 35 34
Software 12 14 16
Networking and Communications 6 7 8
---- ---- ----
Total 100% 100% 100%
==== ==== ====
-4-
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Net sales increased $324.3 million, or 44.3%, to $1,056.7 million in 1999 from
$732.4 million in 1998. The growth in net sales, which included a 34.6% increase
in average order size, was primarily attributable to (i) continued improvements
in merchandising and product mix, including the stocking and sale of computer
systems; (ii) continued expansion and increased productivity of the Company's
outbound telemarketing group; (iii) an increase in the number of catalog
mailings; and (iv) sales attributed to the acquisition of ComTeq in June 1999.
System/memory sales increased to 47.6% of net sales in 1999 from 43.7% in 1998.
Outbound sales increased $304 million, or 77.8%, to $694.9 million in 1999 from
$390.9 million in 1998. The number of catalogs mailed increased by 12.1%, from
42.2 million catalogs in 1998 to 47.3 million catalogs in 1999.
Gross profit increased $36.1 million, or 38.7%, to $129.3 million in 1999 from
$93.3 million in 1998. The increase in gross profit dollars was primarily
attributable to the increase in net sales described above. Gross profit margin
decreased from 12.7% in 1998 to 12.2% in 1999 due primarily to a higher rate of
growth in sales of lower margin computer systems, increased price competition,
decreases in average unit selling prices and an increase in the rate of outbound
sales which generally carry a lower gross margin percentage. However, the
Company continued to generate higher gross profit dollars per order, enabling it
to leverage its operating expenses, as described below. The Company's gross
profit margin may vary based upon vendor support programs, product mix, pricing
strategies, market conditions and other factors.
Selling, general and administrative expenses increased $22.9 million, or 33.4%,
to $91.4 million in 1999 from $68.5 million in 1998, but decreased as a
percentage of sales to 8.6% in 1999 from 9.4% in 1998. The increase in expense
was attributable to 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 the continued leveraging of selling, general and administrative
expenses over a larger sales base.
Income from operations increased by $15.5 million, or 69%, to $37.9 million for
the year ended December 31, 1999 from $22.4 million for the comparable period in
1998. Income from operations as a percentage of net sales increased from 3.1% in
1998 to 3.6% in 1999 for the reasons discussed above.
Interest expense increased by $977,000, or 235.4%, to $1,392,000 in 1999 from
$415,000 in 1998, primarily due to the capital lease obligation for the
Merrimack facility which began in December 1998 and increased borrowings under
the Company's line of credit.
The tax provision for 1999 reflects a full year of the Company being taxed as a
C Corporation. In 1998, the Company's effective tax rate was 17.3% as a result
of both its taxation as an S Corporation for a part of the year as well as the
recognition of certain deferred tax assets upon conversion to a C Corporation.
Net income increased by $4.1 million, or 22%, to $22.7 million in 1999 from
$18.6 million in 1998, principally as a result of the increase in income from
operations. As described above, 1998 net income was also favorably impacted by
the Company's previous S Corporation status and its conversion to a C
Corporation.
-5-
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net sales increased $181.8 million, or 33.0%, to $732.4 million in 1998 from
$550.6 million in 1997. The growth in net sales, which included a 10.7% increase
in average order size, was primarily attributable to (i) continued improvements
in merchandising and product mix, including the stocking and sale of computer
systems; (ii) continued expansion and increased productivity of the Company's
outbound telemarketing group; and (iii) an increase in the number of catalog
mailings. System/memory sales increased to 43.7% of net sales in 1998 from 42.2%
in 1997. Outbound sales increased $133.7 million, or 52.0%, to $390.9 million in
1998 from $257.2 million in 1997. The number of catalogs mailed increased by
24.9%, from 33.8 million catalogs in 1997 to 42.2 million catalogs in 1998.
Gross profit increased $17.3 million, or 22.8%, to $93.3 million in 1998 from
$76.0 million in 1997. The increase in gross profit dollars was primarily
attributable to the increase in net sales described above. Gross profit margin
decreased from 13.8% in 1997 to 12.7% in 1998 due primarily to a higher rate of
growth in sales of lower margin computer systems, increased price competition,
decreases in average unit selling prices and an increase in the rate of charges
to cost of sales for slow-moving and obsolete inventory. However, the Company
continued to generate higher gross profit dollars per order, enabling it to
leverage its operating expenses, as described below. The Company's gross profit
margin may vary based upon vendor support programs, product mix, pricing
strategies, market conditions and other factors.
Selling, general and administrative expenses increased $11.9 million, or 21.1%,
to $68.5 million in 1998 from $56.6 million in 1997, but decreased as a
percentage of sales to 9.4% in 1998 from 10.3% in 1997. The increase in expense
was attributable to 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 the continued leveraging of selling, general and administrative
expenses over a larger sales base.
Additional stockholder/officer compensation paid to the Company's two principal
stockholders, who also serve as officers and directors, represents amounts
accrued or distributed in excess of aggregate annual base salaries ($600,000
aggregate base salaries for 1998 and $480,000 for 1997) approved by the Board of
Directors of the Company and generally represent Company-related federal income
tax obligations payable by the stockholders. Effective upon the closing of the
Offering, these stockholder/officers were paid annual base salaries aggregating
$600,000. Additional stockholder/officer compensation decreased by $9.8 million,
or 80.6%, to $2.4 million in 1998 from $12.1 million in 1997. This decrease is
attributable to the Company's termination of its S Corporation status upon
consummation of the Company's initial public offering (the "Offering"), which
eliminated the need to make further distributions to the stockholder/officers
for payment of Company-related federal income tax obligations.
Income from operations increased by $15.2 million, or 209.4%, to $22.4 million
for the year ended December 31, 1998 from $7.2 million for the comparable period
in 1997. Income from operations as a percentage of net sales increased from 1.3%
in 1997 to 3.1% in 1998 for the reasons discussed above.
-6-
Interest expense decreased by $940,000, or 69.4%, to $400,000 in 1998 from $1.4
million in 1997, primarily due to the repayment of all outstanding borrowings
under the Company's line of credit in March 1998 upon the closing of the
Offering.
Net income increased by $13.4 million, or 258.3%, to $18.6 million in 1998 from
$5.2 million in 1997, principally as a result of the increase in income from
operations.
Liquidity and Capital Resources
The Company has historically financed its operations and capital expenditures
through cash flow from operations and bank borrowings. The Company believes that
funds generated from operations, together with the net proceeds from the
Company's 1998 initial public 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 2000. The Company's ability to
continue funding its planned growth, both internally and externally, 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.
At December 31, 1999, the Company had cash and cash equivalents of $20.4 million
and working capital of $72.3 million.
Net cash provided by operating activities was $16.0 million in the year ended
December 1999, compared to $29.4 million provided and $10.4 million used in the
years ended December 31, 1998, and 1997, respectively. 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 sales to 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.
At December 31, 1999, the Company had $105.5 million in outstanding accounts
payable. 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. This amount includes $31.0 million payable to two financial
institutions under security agreements to facilitate the purchase of inventory.
-7-
Capital expenditures were $7.7 million, $9.9 million and $4.5 million in the
years ended December 31, 1999, 1998 and 1997, respectively. The Company expects
capital expenditures, primarily for the purchase of computer hardware and
software and other fixed assets, to be approximately $16.6 million for the year
ending December 31, 2000.
The Company has an unsecured credit agreement with a bank providing for short-
term borrowings up to $50 million, which bears interest at various rates ranging
from the prime rate (8.50% at December 31, 1999) to prime less 1%, depending on
the ratio of senior debt to EBITDA (earnings before interest, taxes,
depreciation and amortization). The credit agreement includes various customary
financial and operating covenants, including restrictions on the payment of
dividends, none of which the Company believes significantly restricts its
operations. No borrowings were outstanding at December 31, 1999.
The Company has primarily relied upon debt to finance not only ongoing
operations, but acquisitions. In 1999, it used available cash and sellers notes
to acquire ComTeq Federal, Inc., a Maryland company which provides specialty
resale products to agencies of the federal government. Management could, in the
future, use debt, cash, or stock to effect additional acquisitions.
Recently Issued Financial Accounting Standards
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", adjusted to be effective for fiscal years
beginning after June 15, 2000. 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, 2001, 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.
Factors That May Affect Future Results and Financial Condition
The Company's future results and financial condition are dependent on its
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:
The Company has experienced rapid growth in recent years and there is no
- ------------------------------------------------------------------------
assurance that it will be able to manage or sustain such growth.
- ---------------------------------------------------------------
The Company's net sales have grown from $252.2 million for the year ended
December 31, 1995 to $1.1 billion for the year ended December 31, 1999. This
growth has placed, and any future growth will place, increasing demands on the
Company's administrative, operational, financial and other resources. The
Company's staffing levels and operating expenses have increased and are expected
to increase substantially in the future. The Company also expects that any
future growth will continue to challenge its ability to hire, train, motivate
and manage employees. If the Company's net sales do not increase in proportion
to its operating expenses or if the Company experiences a decrease in net sales,
its information systems do not expand to meet increasing demands, or the Company
fails to attract, assimilate and retain qualified personnel or otherwise fail to
manage its growth effectively, there would be a material adverse effect on the
Company's results of operations.
-8-
The Company may not have sufficient distribution facilities to support future
- -----------------------------------------------------------------------------
growth.
- ------
The Company's current distribution facilities may be inadequate to support any
significant growth in the future. The Company currently occupies two buildings
aggregating 205,000 square feet in Wilmington, Ohio under leases which expire in
2000 and 2003. There is no assurance that the Company can renew these leases on
favorable terms or at all. The Company is continually assessing its needs for
additional warehouse facilities. There can be no assurance that suitable
commercial facilities will be available, or if available, that such facilities
would be available at commercially reasonable rates.
The Company could experience system failures which would interfere with its
- ---------------------------------------------------------------------------
ability to process orders.
- -------------------------
The Company depends on the accuracy and proper use of its management information
systems including its telephone system. Many of the Company's key functions
depend on the quality and effective utilization of the information generated by
its management information systems, including:
. the Company's ability to manage inventory and accounts receivable
collections;
. the Company's ability to purchase, sell and ship products efficiently and on
a timely basis; and
. the Company's ability to maintain operations.
Interruptions could result from natural disasters as well as power loss,
- ------------------------------------------------------------------------
telecommunications failure and similar events.
- ----------------------------------------------
The Company's management information systems require continual upgrades to most
effectively manage its operations and customer database. Although the Company
maintains some redundant systems, with full data backup, a substantial
interruption in management information systems or in telephone communication
systems would substantially hinder its ability to process customer orders and
thus could have a material adverse effect on the Company's business, results of
operations and financial condition.
The Company is exposed to inventory obsolescence due to the rapid technological
- -------------------------------------------------------------------------------
changes occurring in the personal computer industry.
- ---------------------------------------------------
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 large part on its ability to
identify and market products that meet the needs of customers in that
marketplace. In order to satisfy customer demand and to obtain favorable
purchasing discounts, the Company has and may continue to carry increased
inventory levels of certain products. By so doing, it is subject to the
increased risk of inventory obsolescence. Also, in order to implement its
business strategy, the Company intends, among other things, to place larger than
typical inventory stocking orders, and increase participation in first-to-market
purchase opportunities. In the future, the Company may also participate in end-
of-life-cycle purchase opportunities and market products on a private-label
basis, which would increase the risk of inventory obsolescence. In addition, the
Company sometimes acquires special purchase products without return privileges.
There can be no assurance that the Company will be able to avoid losses related
to obsolete inventory. In addition, manufacturers are limiting return rights and
are also taking steps to reduce their inventory exposure by supporting "build to
order" programs authorizing distributors and resellers to assemble computer
hardware under the manufacturers' brands. These trends reduce the costs to
manufacturers and shift the burden of inventory risk to resellers like the
Company which could negatively impact the Company's business, financial
condition and results of operations.
-9-
The Company acquires products for resale from a limited number of vendors; the
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loss of any one of these vendors could have a material adverse effect on its
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business.
- ---------
The Company acquires products for resale both directly from manufacturers and
indirectly through distributors and other sources. The five vendors supplying
the greatest amount of goods to the Company constituted 50.7% and 44.5% of the
Company's total product purchases in the years ended December 31, 1999 and 1998,
respectively. Among these five vendors, purchases from Ingram Micro, Inc.
represented 21.7% and 20.3% of the Company's total product purchases in the
years ended December 31, 1999 and 1998, respectively. No other vendor supplied
more than 10% of the Company's total product purchases in the year ended
December 31, 1999. If the Company were unable to acquire products from Ingram
Micro, the Company could experience a short-term disruption in the availability
of products and such disruption could have a material adverse effect on the
Company's 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 it with trade credit, of which the net amount outstanding at
December 31, 1999 was $83.2 million. Termination, interruption or contraction of
relationships with the Company's 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.
Some 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. The
availability of certain desired products, especially in the direct marketing
channel, has been constrained in the past. The Company could experience a
material adverse effect to its business if the Company is unable to source
first-to-market purchase or similar opportunities, or if the Company faces the
reemergence of significant availability constraints.
The Company may experience a reduction in the incentive programs offered to it
- ------------------------------------------------------------------------------
by vendors.
- ----------
Some product manufacturers and distributors provide the Company with incentives
such as supplier reimbursements, payment discounts, price protection, rebates
and other similar arrangements. The increasingly competitive computer hardware
market has already resulted in the following:
. reduction or elimination of some of these incentive programs,
. more restrictive price protection and other terms; and
. in some cases, reduced advertising allowances and incentives.
Most product manufacturers provide the Company with co-op advertising support
and in exchange the Company covers their products in the Company's catalogs.
This support significantly defrays the Company's catalog production expense. In
the past, the Company has experienced a decrease in the level of co-op
advertising support available to it from certain manufacturers. The level of co-
op advertising support the Company receives 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 cash flows.
The Company faces many competitive risks.
- ----------------------------------------
The direct marketing industry and the computer products retail business, in
particular, are highly competitive. The Company competes with consumer
electronics and computer retail stores, including superstores. The Company also
competes with other direct marketers of hardware and software and computer
related products, including an increasing number of Internet retailers, some of
which sell products at or below cost. Certain hardware and software vendors are
selling their products directly through their own catalogs and over the
Internet. 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 have greater financial, marketing and larger catalog
circulations and customer bases and other resources than does the Company. In
addition, many of the Company's competitors offer a wider range of products and
services than it does and may be able to respond more quickly to new or changing
opportunities, technologies and customer requirements. Many current and
potential competitors also have greater name recognition, engage in more
extensive promotional activities and adopt more aggressive pricing policies than
the Company. The Company expects competition to increase as retailers and direct
marketers who have not traditionally sold computers and related products enter
the industry.
-10-
The Company cannot assure that it can continue to compete effectively against
its current or future competitors. In addition, price is an important
competitive factor in the personal computer hardware and software market and the
Company cannot assure that the Company will not face increased price
competition. If the Company encounters new competition or fails to compete
effectively against competitors, its business, financial condition and results
of operations could be adversely affected.
In addition, product resellers and direct marketers are combining operations or
acquiring or merging with other resellers and direct marketers to increase
efficiency. Moreover, current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties to
enhance their products and services. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and acquire significant
market share.
The Company faces and will continue to face significant and intense price
- -------------------------------------------------------------------------
competition.
- -----------
Generally, pricing is very aggressive in the personal computer industry and the
Company expects pricing pressures to continue. An increase in price competition
could result in a reduction of the Company's profit margins. There can be no
assurance that the Company will be able to offset the effects of price
reductions with an increase in the number of customers, higher sales, cost
reductions or otherwise. Also, the Company's recent increase in sales of
personal computer hardware products are generally producing lower profit margins
than those associated with software products. Such pricing pressures could
result in an erosion of the Company's market share, reduced sales and reduced
operating margins, any of which could have a material adverse effect on the
Company's business.
Privacy concerns with respect to list development and maintenance may
- ---------------------------------------------------------------------
materially adversely affect the Company's business.
- --------------------------------------------------
The Company mails catalogs and sends electronic messages to names in its
proprietary customer database and to potential customers whose names the Company
obtains from rented or exchanged mailing lists. Worldwide public concern
regarding personal privacy has subjected the rental and use of customer mailing
lists and other customer information to increased scrutiny. Any domestic or
foreign legislation enacted limiting or prohibiting these practices could
negatively affect the Company's business, financial condition and results of
operations.
The Company relies on the continued development of electronic commerce and
- --------------------------------------------------------------------------
Internet infrastructure development.
- -----------------------------------
The Company's level of sales made over the Internet has increased in part
because of the growing use and acceptance of the Internet by end-users. This
growth is a recent development. No one can be certain that acceptance and use of
the Internet will continue to develop or that a sufficiently broad base of
consumers will adopt and continue to use the Internet and other online services
as a medium of commerce. Sales of computer products over the Internet do not
currently represent a significant portion of overall computer product sales.
Growth of the Company's Internet sales is dependent on potential customers using
the Internet in addition to traditional means of commerce to purchase products.
The Company cannot accurately predict the rate at which they will do so.
The Company's success in growing its Internet business will depend in large part
upon the development of an infrastructure for providing Internet access and
services. If the number of Internet users or their use of Internet resources
continues to grow rapidly, such growth may overwhelm the existing Internet
infrastructure. The Company's ability to increase the speed with which it
provides services to customers and to increase the scope of such services
ultimately is limited by and reliant upon the speed and reliability of the
networks operated by third parties. The Company cannot assure that networks and
infrastructure providing sufficient capacity and reliability will continue to be
developed.
-11-
The Company depends heavily on third-party shippers to deliver its products to
- -------------------------------------------------------------------------------
customers.
- ---------
The Company ships approximately 65% of its products to customers by Airborne
Freight Corporation D/B/A "Airborne Express", with the remainder being shipped
by United Parcel Service of America, Inc. and other overnight delivery and
surface services. A strike or other interruption in service by these shippers
could adversely affect the Company's ability to market or deliver products to
customers on a timely basis.
The Company may experience potential increases in shipping, paper and postage
- ------------------------------------------------------------------------------
costs, which may adversely effect its business if the Company were not able to
- ------------------------------------------------------------------------------
pass such increases on to its customers.
- ---------------------------------------
Shipping costs are a significant expense in the operation of the Company's
business. Increases in postal or shipping rates and paper costs could
significantly impact the cost of producing and mailing the Company's catalogs
and shipping customer orders. Postage prices and shipping rates increase
periodically and the Company has no control over future increases. The Company
has a long-term contract with Airborne Express whereby it ships products to the
Company's customers. The Company believes that it has negotiated favorable
shipping rates with Airborne. The Company generally invoices customers for
shipping and handling charges. There can be no assurance that the Company will
be able to pass on to its customers the full cost, including any future
increases in the cost, of commercial delivery services such as Airborne Express.
The Company also incurs substantial paper and postage costs related to its
marketing activities, including producing and mailing its catalogs. Paper prices
historically have been cyclical and the Company has experienced substantial
increases in the past. Significant increases in postal or shipping rates and
paper costs could adversely impact the Company's business, financial condition
and results of operations, particularly if the Company cannot pass on such
increases to its customers or offset such increases by reducing other costs.
The Company may also experience quarterly fluctuations and seasonality which
- -----------------------------------------------------------------------------
could impact its business.
- -------------------------
Several factors have caused the Company's sales and results of operations to
fluctuate, and the Company expects these fluctuations to continue on a quarterly
basis. Causes of these fluctuations include:
. the condition of the personal computer industry in general;
. shifts in demand for hardware and software products;
. industry shipments of new products or upgrades;
. the timing of new merchandise and catalog offerings;
. fluctuations in response rates;
. fluctuations in postage, paper, shipping and printing costs and in
merchandise returns;
. adverse weather conditions that affect response, distribution or shipping;
. shifts in the timing of holidays; and
. changes in the Company's product offerings.
The Company bases its operating expenditures on sales forecasts. If revenues do
not meet expectations in any given quarter, the Company's operating results
could suffer.
In addition, customer response rates to the Company's catalog mailings are
subject to variations. The first and last quarters of the year generally have
higher response rates while the two middle quarters typically have lower
response rates.
-12-
The methods of distributing personal computers and related products are changing
- --------------------------------------------------------------------------------
and such changes may negatively impact the Company and its business.
- -------------------------------------------------------------------
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. Some of the Company's vendors, including Apple,
Compaq and IBM, currently sell some of their products directly to end users and
have stated their intentions to increase the level of such direct sales. 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 results of operations.
The Company faces many uncertainties relating to the collection of state sales
- ------------------------------------------------------------------------------
or use tax.
- ----------
The Company presently collects sales tax only on sales of products to residents
of Ohio, Tennessee, Maryland and the District of Columbia. The Company began
collecting sales tax in Massachusetts in January 2000. Sales to customers
located within Ohio, Tennessee, Maryland and the District of Columbia were less
than 2% of the Company's net sales during the year ended December 31, 1999.
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 us 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 the Company ships products would result in
additional administrative expenses to the Company, could result in price
increases to its customers, and could reduce demand for its product.
The Company is dependent 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 sales 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 the
Company's business objectives.
The Company is controlled by two principal stockholders.
- -------------------------------------------------------
Patricia Gallup and David Hall, the Company's two principal stockholders,
beneficially own or control, in the aggregate, approximately 75% of the
outstanding shares of the Company's 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 control decisions to adopt, amend or repeal the Company's
charter and bylaws, or take other actions requiring the vote or consent of the
Company's stockholders and 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
Company's public stockholders. In connection with the Company's initial public
offering, the principal stockholders placed all except 30,000 of the shares of
common stock beneficially owned by them 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 Company's
common stock at a premium as well as have a negative impact on the market price
of the Company's common stock.
-13-
===============================================================================
Item 7A. Quantitative and Qualitative Disclosure 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. In addition, the
Company's Credit Agreement provides for borrowings which bear interest at
variable rates based on the prime rate. The Company had no borrowings
outstanding pursuant to the Credit Agreement as of December 31, 1999. 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.
===============================================================================
Item 8. Consolidated Financial Statements and Supplementary Data
===============================================================================
The information required by this Item is included in this Report beginning at
page F-1.
-14-
PC CONNECTION, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Management............................................................................. F-2
Independent Auditors' Report..................................................................... F-3
Consolidated Balance Sheets as of December 31, 1999 and 1998..................................... F-4
Consolidated Statements of Income for the years ended December 31, 1999, 1998, and 1997.......... F-5
Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31,
1999, 1998, and 1997........................................................................ F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998, and 1997...... F-7
Notes to Consolidated Financial Statements....................................................... F-8
F-1
REPORT OF MANAGEMENT
Responsibility for the integrity and objectivity of the financial information
presented in this Annual Report on Form 10-K rests with PC Connection, Inc. and
subsidiary ("the Company") management. The accompanying financial statements
have been prepared in conformity with generally accepted accounting principles,
applying certain estimates and judgments as required.
The Company maintains an effective internal control structure. It consists, in
part, of an organization with clearly defined lines of responsibility and
delegation of authority, comprehensive systems and control procedures. We
believe this structure provides reasonable assurance that transactions are
executed in accordance with management authorization and generally accepted
accounting principles.
To assure the effective administration of internal control, we carefully select
and train our employees, develop and disseminate written policies and
procedures, provide appropriate communication channels and foster an environment
conducive to the effective functioning of controls. We believe that it is
essential for the Company to conduct its business affairs in accordance with the
highest ethical standards.
Deloitte & Touche LLP, independent auditors, is retained to audit the Company's
consolidated financial statements. Its accompanying report is based on an audit
conducted in accordance with auditing standards generally accepted in the United
States of America.
The Audit Committee of the Board of Directors is composed solely of outside
directors and is responsible for recommending to the Board of Directors the
independent accounting firm to be retained for the coming year. The Audit
Committee meets periodically and privately with the independent auditors, as
well as with Company management, to review accounting, auditing, internal
control structure and financial reporting matters.
Patricia Gallup Wayne L. Wilson Mark A. Gavin
Chairman and President and Chief Chief Financial Officer
Chief Executive Officer Operating Officer
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
PC Connection, Inc. and Subsidiary
Merrimack, New Hampshire
We have audited the accompanying consolidated balance sheets of PC Connection,
Inc. and subsidiary as of December 31, 1999 and 1998, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1999. Our
audits also included the financial statement schedule listed in Item 14(a)(2).
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of PC Connection, Inc. and subsidiary
as of December 31, 1999 and 1998, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
Deloitte & Touche LLP
Boston, Massachusetts
January 26, 2000
F-3
PC CONNECTION, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)
December 31,
-------------------
1999 1998
---- ----
ASSETS
Current Assets:
Cash and cash equivalents............................ $ 20,416 $ 11,910
Accounts receivable, net............................. 99,405 58,890
Inventories - merchandise............................ 64,348 63,425
Deferred income taxes................................ 1,991 3,181
Prepaid expenses and other current assets............ 4,651 4,115
-------- --------
Total current assets................................. 190,811 141,521
Property and equipment, net............................ 23,126 22,675
Deferred income taxes.................................. - 314
Other assets........................................... 169 -
Goodwill............................................... 9,431 -
-------- --------
Total Assets..................................... $223,537 $164,510
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease obligation
to affiliate....................................... $ 137 $ 123
Current maturities of long-term debt................. 1,000 -
Accounts payable..................................... 105,547 77,561
Accrued expenses and other liabilities............... 11,877 10,069
-------- --------
Total current liabilities........................ 118,561 87,753
Notes payable, less current maturities................. 2,000 -
Capital lease obligation to affiliate,
less current maturities............................... 6,945 7,081
Deferred taxes......................................... 1,579 -
Other liabilities...................................... 229 -
-------- --------
Total Liabilities................................ 129,314 94,834
-------- --------
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Preferred Stock, $.01 par value, 7,500 shares
authorized, 0 outstanding at December 31, 1999
and December 31, 1998............................ - -
Common Stock, $.01 par value, 30,000 shares
authorized, 15,767 and 15,605 issued and
outstanding at December 31, 1999 and December 31,
1998, respectively............................... 158 156
Additional paid-in capital ........................... 58,627 56,812
Retained earnings..................................... 35,438 12,708
-------- --------
Total Stockholders' Equity........................ 94,223 69,676
-------- --------
Total Liabilities and Stockholders' Equity........ $223,537 $164,510
======== ========
See notes to consolidated financial statements.
F-4
PC CONNECTION, INC.
CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share data)
Years Ended December 31,
-------------------------------------
1999 1998 1997
----------- ---------- ---------
Net sales.................................................. $ 1,056,704 $ 732,370 $ 550,575
Cost of sales.............................................. 927,358 639,096 474,609
----------- ---------- ---------
Gross Profit............................................. 129,346 93,274 75,966
Selling, general and administrative expenses............... 91,405 68,521 56,596
Additional stockholder/officer compensation................ - 2,354 12,130
----------- ---------- ---------
Income from operations................................... 37,941 22,399 7,240
Interest expense........................................... (1,392) (415) (1,355)
Other, net................................................. 116 565 (42)
----------- ---------- ---------
Income before taxes........................................ 36,665 22,549 5,843
Income taxes............................................... (13,935) (3,905) (639)
----------- ---------- ---------
Net income............................................... $ 22,730 $ 18,644 $ 5,204
=========== ========== =========
Earnings per common share:
Basic.................................................... $ 1.45
===========
Diluted.................................................. $ 1.41
===========
Pro forma data:
Historical income before income taxes..................... $ 22,549 $ 5,843
Pro forma income taxes.................................... (8,721) (2,279)
---------- ---------
Pro forma net income...................................... $ 13,828 $ 3,564
========== =========
Pro forma basic net income per share...................... $ .91 $ .26
========== =========
Pro forma diluted net income per share.................... $ .88 $ .25
========== =========
See notes to consolidated financial statements.
F-5
PC CONNECTION, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(amounts in thousands)
Additional
Common Stock Paid-In Retained
------------
Shares Amount Capital Earnings Total
------ ------ ------- -------- -----
Balance, January 1, 1997............................ 11,799 $ 118 $ 3,224 $ 14,701 $ 18,043
Compensation under nonstatutory stock
option agreements................................. - - 873 - 873
Net Income.......................................... - - - 5,204 5,204
--------- ------ -------- -------- --------
Balance, December 31, 1997.......................... 11,799 118 4,097 19,905 24,120
--------- ------ -------- -------- --------
Net proceeds from initial public offering........... 3,594 36 57,217 - 57,253
Dividend............................................ - - (7,196) (25,841) (33,037)
Exercise of stock options, including
income tax benefits............................... 212 2 1,397 - 1,399
Compensation under nonstatutory
stock option agreements........................... - - 1,297 - 1,297
Net income.......................................... - - - 18,644 18,644
--------- ------ -------- -------- --------
Balance, December 31, 1998.......................... 15,605 156 56,812 12,708 69,676
--------- ------ -------- -------- --------
Exercise of stock options, including
income tax benefits............................... 117 1 1,183 - 1,184
Issuance of stock under employee
stock purchase plan............................... 45 1 470 - 471
Compensation under nonstatutory
stock option agreements........................... - - 162 - 162
Net income.......................................... - - - 22,730 22,730
--------- ------ -------- -------- --------
Balance, December 31, 1999.......................... 15,767 $ 158 $ 58,627 $ 35,438 $ 94,223
========= ====== ======== ========= ========
See notes to consolidated financial statements.
F-6
PC CONNECTION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
Years Ended December 31,
----------------------------------------
1999 1998 1997
----------- ----------- ----------
Cash Flows from Operating Activities:
Net income................................................... $ 22,730 $ 18,644 $ 5,204
Adjustments to reconcile net income to net cash provided
by (used for) operating activities:
Depreciation and amortization.............................. 5,334 2,866 3,660
Deferred income taxes...................................... 2,523 (1,945) (154)
Compensation under nonstatutory stock option agreements.... 162 1,297 873
Provision for doubtful accounts............................ 6,821 6,296 3,339
Loss on disposal of fixed assets........................... 159 - 54
Changes in assets and liabilities:
Accounts receivable........................................ (42,795) (35,265) (10,097)
Inventories................................................ (305) 295 (19,301)
Prepaid expenses and other current assets.................. (504) (1,910) (483)
Accounts payable........................................... 19,945 39,387 1,269
Amounts payable to stockholders............................ - (1,185) 1,185
Accrued expenses and other liabilities..................... 1,969 926 4,042
--------- ---------- --------
Net cash provided by (used for) operating activities......... 16,039 29,406 (10,409)
--------- ---------- --------
Cash Flows from Investing Activities:
Purchases of property and equipment.......................... (7,653) (9,922) (4,528)
Proceeds from sale of property and equipment................. 2,155 58 22
Payment for purchase of ComTeq, net of cash acquired......... (3,198) - -
--------- ---------- --------
Net cash used for investing activities....................... (8,696) (9,864) (4,506)
--------- ---------- --------
Cash Flows from Financing Activities:
Proceeds from short-term borrowings.......................... 442,731 160,098 178,362
Repayment of short-term borrowings........................... (442,731) (188,416) (162,351)
Repayment of term loan....................................... - (4,500) (500)
Repayment of capital lease obligation to affiliate........... (122) (11) -
Issuance of stock upon exercise of stock options............. 814 223 -
Issuance of stock under Employee Stock Purchase Plan......... 471 - -
Net proceeds from initial public offering.................... - 57,253 -
Payment of dividend.......................................... - (33,037) -
---------- ---------- --------
Net cash provided by (used for) financing activities......... 1,163 (8,390) 15,511
---------- ---------- --------
Increase in cash and cash equivalents........................ 8,506 11,152 596
Cash and cash equivalents, beginning of period............... 11,910 758 162
---------- ---------- --------
Cash and cash equivalents, end of period..................... $ 20,416 $ 11,910 $ 758
========== ========== ========
Supplemental Cash Flow Information:
Interest paid................................................ $ 1,398 $ 497 $ 1,334
Income taxes paid............................................ 9,374 7,275 550
Non-cash Activities:
Issuance of notes payable in connection with
acquisition of subsidiary.................................. $ 3,000 $ - $ -
Assets acquired under capital lease.......................... - 7,215 -
See notes to consolidated financial statements.
F-7
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except per share data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PC Connection, Inc. and its subsidiary (the "Company") is a direct marketer of
brand-name personal computers and related peripherals, software, and networking
products to business, education, government, and consumer end users located
primarily in the United States. The following is a summary of significant
accounting policies.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of PC Connection,
Inc. and its wholly-owned subsidiary. Intercompany transactions and balances are
eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
These estimates and assumptions affect the amounts reported in the accompanying
financial statements. Actual results could differ from those estimates.
Revenue Recognition
Revenue on product sales is recognized at the point of shipment. A reserve for
sales returns is recorded at the time of sale and has been established based
upon historical trends.
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. The carrying value of the
Company's cash equivalents approximates fair value.
Inventories - Merchandise
Inventories (all finished goods) consisting of software packages, computer
systems and peripheral equipment, are stated at cost (determined under the
first-in, first-out method) or market, whichever is lower.
Advertising Costs and Revenues
Costs of producing and distributing catalogs are deferred and charged to expense
over the period that each catalog remains the most current selling vehicle
(generally one to two months). Other advertising costs are expensed as incurred.
Vendors have the ability to place advertisements in the catalogs for which the
Company receives advertising allowances and incentives. These revenues are
recognized on the same basis as the catalog costs.
Advertising costs charged to expense were $31,487, $32,498 and $27,859 for the
years ended December 31, 1999, 1998 and 1997, respectively. Deferred advertising
revenues at December 31, 1999 and 1998 exceeded deferred advertising costs of
$423 and $325 at those respective dates, and, accordingly, such net deferred
amounts are included in accrued expenses and other liabilities.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization is
provided for both financial and income tax reporting purposes over the estimated
useful lives of the assets ranging from three to seven years, computer software,
including licenses and internally developed software is capitalized and
amortized over lives ranging from three to five years. Depreciation is and has
been provided using accelerated methods for property acquired prior to 1996 and
on the straight-line method for property acquired thereafter. Leasehold
improvements and facilities under capital leases are amortized over the terms of
the related leases or their useful lives, whichever is shorter, whereas for
income tax reporting purposes, they are amortized over the applicable tax lives.
The Company periodically evaluates the carrying value of property and equipment
based upon current and anticipated undiscounted cash flows, and recognizes an
impairment when it is probable that such estimated future cash flows will be
less than the asset carrying value.
F-8
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Goodwill
Goodwill arises from certain purchase transactions and is amortized using the
straight-line method over appropriate periods not exceeding 15 years. The amount
charged to expense during 1999 was $324.
Tax Status and Income Taxes
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 Company's initial
public offering of its common stock on March 6, 1998 (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.
Deferred income tax assets and liabilities are computed for differences between
the financial statement and tax basis of assets and liabilities that will result
in taxable or deductible amounts in the future, based on enacted tax laws and
rates applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount that is more likely than not to be realized.
"Income taxes" as presented on the Consolidated Statements of Income comprise
the tax payable or refundable for the period plus or minus the change during the
period in deferred tax assets and liabilities.
Additional Stockholder/Officer Compensation
Additional stockholder/officer compensation represents amounts accrued or
distributed in excess of aggregate annual base salaries approved by the Board of
Directors (the "Board") and generally represents Company-related federal income
tax obligations payable by the stockholders for periods during which the Company
was an S Corporation.
Concentration of Credit Risk
Concentrations of credit risk with respect to trade account receivables are
limited due to the large number of customers comprising the Company's customer
base. Ongoing credit evaluations of customers' financial condition are
performed.
Earnings Per Share
Basic earnings per common share is computed using the weighted average number of
shares outstanding. Diluted earnings per share is computed using the weighted
average number of shares outstanding adjusted, when dilutive, for the
incremental shares attributed to outstanding options to purchase common stock.
The denominator pro forma basic earnings per share for all periods prior to
March 6, 1998 includes the weighted average shares required to pay the S
Corporation dividend (assuming a price per share of $17.50 for the year ended
December 31, 1998 and $16.00 for the year ended December 31, 1997).
The following table sets forth the computation of basis and diluted earnings per
share:
Pro Forma
---------
(amounts in thousands, except per share data) 1999 1998 1997
---- ---- ----
Numerator:
Net income $ 22,730 $13,828 $ 3,564
Denominator:
Denominator for basic earnings per share:
Weighted average shares 15,650 14,849 11,799
Weighted average shares required to
pay stockholder dividend - 316 2,062
-------- ------- -------
Denominator for basic earnings per share 15,650 15,165 13,861
-------- ------- -------
Effect of dilutive securities:
Employee stock options 461 504 383
-------- ------- -------
Denominator for diluted earnings per share 16,111 15,669 14,244
======== ======= =======
Earnings per share:
Basic $ 1.45 $ .91 $ .26
======== ======= =======
Diluted $ 1.41 $ .88 $ .25
======== ======= =======
F-9
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The above pro forma adjustments have been made to the historical results of
operations for the period from January 1 through March 5, 1998 and the year
ended December 31, 1997 to make the pro forma presentation comparable to what
would have been reported had the Company operated as a C Corporation.
(i) Computation of income tax expense assuming an effective tax rate of
approximately 39%. (See Note 9)
The following stock options to purchase Common Stock were excluded from the
computation of diluted earnings per share for years ended December 31, 1999,
1998, and 1997 because the effect of the options on the calculation would have
been anti-dilutive:
1999 1998 1997
---- ---- ----
Anti-dilutive stock options - 78 -
Stock-Based Compensation
Compensation expense associated with awards of stock or options to employees is
measured using the intrinsic value method in accordance with APB Opinion No. 25.
The Board estimated the fair value of the Company's stock for awards made prior
to the Offering using market valuations of comparable publicly traded companies,
among other factors.
Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income", which requires businesses to disclose comprehensive
income and its components in their general-purpose financial statements. The
Company has no other comprehensive income in any of the periods presented.
Accordingly, a separate statement of comprehensive income is not presented.
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, 2000. 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, 2001, as required.
Reclassifications
Certain amounts in the 1998 and 1997 financial statements have been reclassified
to conform to the 1999 presentation.
2. ACQUISITION OF SUBSIDIARY
On June 29, 1999, the Company acquired all of the outstanding stock of ComTeq
Federal, Inc., a supplier of computer equipment and services to federal
government agencies. The purchase price was $8.3 million, including acquisition
costs and consisted of cash of $5.3 million and promissory notes aggregating $3
million. Total cash paid for ComTeq Federal Inc., net of cash acquired, was $3.2
million. The transaction has been accounted for by the purchase method, and
accordingly, the results of operations for the period from June 29, 1999 to
December 31, 1999 are included in the accompanying financial statements. The
assets purchased and liabilities assumed have been recorded at their fair value
at the date of acquisition. The excess of the purchase price, including
acquisition costs, over the fair value of the liabilities assumed has been
recorded as goodwill (approximately $9.7 million). Such amount recorded at
December 31, 1999 is subject to change pending final valuation of the net assets
acquired. Goodwill will be amortized over a period of 15 years. The promissory
notes are unsecured, bear interest at the prime rate less 0.5% and are scheduled
to be repaid over a three year period. As of December 31, 1999, the short-term
portion of the promissory notes was $1 million and the long-term portion was $2
million.
F-10
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Pro Forma Information
The following unaudited pro forma information presents the consolidated results
of operations of the Company as if the acquisition of ComTeq Federal, Inc. had
taken place as of the beginning of each of the periods presented.
Year Ended December 31,
(in thousands except per share data)
1999 1998
---- ----
Revenues $1,081,533 $769,567
Net income 23,350 14,647
Diluted earnings per share 1.45 .93
3. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
December 31,
----------------------
1999 1998
-------- --------
Trade......................................... $ 96,981 $ 47,667
Co-op advertising............................. 2,965 6,131
Vendor returns, rebates and other............. 7,109 14,243
-------- --------
Total......................................... 107,055 68,041
Less allowances for:
Sales returns............................ (3,717) (4,030)
Doubtful accounts........................ (3,933) (5,121)
-------- --------
Accounts receivable, net...................... $ 99,405 $ 58,890
======== ========
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
December 31,
------------------
1999 1998
-------- --------
Facilities under capital lease.................... $ 7,215 $ 7,215
Leasehold improvements............................ 5,337 5,225
Furniture and equipment........................... 22,923 22,484
Computer software, including licenses
and internally-developed software............... 10,749 7,873
Automobiles....................................... 224 192
-------- --------
Total........................................ 46,448 42,989
Less accumulated depreciation and amortization.... (23,322) (20,314)
-------- --------
Property and equipment, net....................... $ 23,126 $ 22,675
======== ========
5. BANK BORROWINGS
At December 31, 1999, the Company has an unsecured credit agreement with a bank
providing for short-term borrowing up to $50 million which bears interest at
various rates ranging from the prime rate (8.50% at December 31, 1999) to prime
rate less 1% depending on the ratio of senior debt to EBITDA. The credit
agreement includes various customary financial and operating covenants,
including minimum net worth requirements, minimum net income requirements and
restrictions on the payment of dividends, none of which, in the opinion of
management, significantly restricts the Company's operations. No amounts were
outstanding under this facility at December 31, 1999. The credit agreement
matures on May 31, 2002.
F-11
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Certain information with respect to short-term borrowings were as follows:
Weighted Average Maximum Amount Average Amount
Interest Rate Outstanding Outstanding
------------- ----------- -----------
Year ended December 31,
1999......................... 7.4% $29,543 $4,497
1998......................... 8.2 28,307 4,145
1997......................... 8.6 31,890 9,458
6. TRADE CREDIT ARRANGEMENTS
At December 31, 1999 and 1998, the Company had security agreements with two
financial institutions to facilitate the purchase of inventory from various
suppliers under certain terms and conditions. The agreements allow a
collateralized position in inventory financed by the financial institutions up
to an aggregated amount of $54.5 million. The cost of such financing under
these agreements is borne by the suppliers. At December 31, 1999 and 1998,
accounts payable included $31,064 and $21,820, respectively owed to these
financial institutions.
7. CAPITAL LEASE
In November 1997, the Company entered into a fifteen-year lease for a new
corporate headquarters with an affiliated company related to the Company
through common ownership. The Company occupied the facility upon completion
of construction in late November 1998, and the lease payments commenced in
December 1998. Annual lease payments under the terms of the lease, as
amended, will be approximately $911 for the first five years of the lease,
increasing to $1,025 for years six through ten and $1,139 for years
eleven through fifteen. The lease requires the Company to pay its proportionate
share of real estate taxes and common area maintenance charges as additional
rent and also to pay insurance premiums for the leased property. The Company
has the option to renew the lease for two additional terms of five years each.
In December 1998, the Company recorded the lease as a capital lease. The
recorded value of the asset (facilities under capital lease) and the related
liability (capital lease obligation to affiliate) was $7.2 million, and during
1999 and 1998, the Company made principal and interest payments under this lease
aggregating $911 thousand and $76 thousand, respectively.
Future aggregate minimum annual lease payments under this lease at December 31,
1999 are as follows:
Year Ending December 31 Payments
----------------------- --------
2000.................................................. $ 911
2001.................................................. 911
2002.................................................. 911
2003.................................................. 921
2004.................................................. 1,025
2005 and thereafter................................... 9,714
-------
Total minimum payments (excluding taxes,
maintenance and insurance).......................... 14,393
Less amount representing interest..................... (7,311)
-------
Present value of minimum lease payments............... 7,082
Less current maturities............................... (137)
-------
Long-term portion..................................... $ 6,945
=======
F-12
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. STOCKHOLDERS' EQUITY
Recapitalization and Reincorporation
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.
Reincorporation of the Company
Contemporaneous with the consummation of the Company's initial public offering,
the Company was reincorporated in Delaware. All of the issued and outstanding
shares of Series A Non-Voting Common Stock, $0.1 par value per share, and Series
B Voting Common Stock, $.01 par value per share, of the New Hampshire
corporation were converted into 11,798,793 shares of Common Stock, $.01 par
value, of the Delaware corporation on a one-for-one basis, and the Series A and
Series B shares were canceled. The effect of the conversion has been reflected
in the Consolidated Statement of Changes in Stockholders' Equity for all periods
presented.
Preferred Stock
The Amended and Restated Certificate of Incorporation of the Delaware
Corporation (the "Restated Certificate") authorized the issuance of up to
7,500,000 shares of preferred stock, $.01 par value per share (the "Preferred
Stock"). Under the terms of the Restated Certificate, the Board is authorized,
subject to any limitations prescribed by law, without stockholder approval, to
issue by a unanimous vote such shares of Preferred Stock in one or more series.
Each such series of Preferred Stock shall have such rights, preferences,
privileges and restrictions, including voting rights, dividend rights,
redemption privileges and liquidation preferences, as shall be determined by the
Board. There were no preferred shares outstanding at 1999 and 1998.
Incentive and Non-statutory Stock Option Plans
In December 1993, the Board adopted and the stockholders approved the 1993
Incentive and Non-Statutory Stock Option Plan (the "1993 Plan"). Under the terms
of the 1993 Plan, the Company is authorized to make awards of restricted stock
and to grant incentive and non-statutory options to employees of, and
consultants and advisors to, the Company to purchase shares of the Company's
stock. A total of 1,124,163 shares of the Company's Common Stock was authorized
for issuance upon exercise of options granted or awards made under the 1993
Plan. Options vest over varying periods up to four years and have contractual
lives up to ten years.
In November 1997, the Board adopted and the stockholders approved the 1997 Stock
Incentive Plan (the "1997 Plan"), which became effective on the closing of the
Offering, and 800,000 shares were reserved for issuance under the Plan. The 1997
Plan provides for the grant of incentive stock options, non-statutory stock
options, stock appreciation rights, performance shares and awards of restricted
stock and unrestricted stock. In April 1999, the Board adopted, and in May 1999
the stockholders approved, an additional 800,000 shares of Common Stock for
issuance under the 1997 Plan.
F-13
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Information regarding the 1993 and 1997 Plans is as follows:
Weighted
Average Weighted
Option Exercise Average
Shares Price Fair Value
------ -------- ----------
Outstanding, January 1, 1997.......... 589,940 1.89
Granted......................... 504,070 4.97 4.22
Outstanding, December 31, 1997........ 1,094,010 3.31
Granted......................... 780,363 17.77 8.11
Exercised....................... (212,648) 1.05
Forfeited....................... (56,155) 7.66
---------
Outstanding, December 31, 1998........ 1,605,570 10.53
---------
Granted......................... 476,555 15.54 6.44
Exercised....................... (117,269) 6.93
Forfeited....................... (83,116) 13.53
---------
Outstanding, December 31, 1999........ 1,881,740 11.89
=========
The weighted average exercise price and weighted average fair value of options
granted in 1999 whose exercise price is equal to the market price on the date of
grant is $14.61 and $6.68, respectively.
The weighted average exercise price and weighted average fair value of options
granted in 1999 whose exercise price is greater than the market price on the
date of grant is $17.50 and $5.92, respectively.
The following table summarizes the status of outstanding stock options as of
December 31, 1999:
Options Outstanding Options Exercisable
------------------------------------ ----------------------
Weighted
Average Weighted Weighted
Exercise No. of Remaining Average No. of Average
Price Range Shares Life (Years) Exercise Price Shares Exercise Price
----------- ------ ----------- -------------- ------ --------------
$.76 278,798 4.64 $ .76 272,244 $ .76
$ .76 - $ 3.81 177,485 6.61 3.12 170,931 3.10
$ 5.72 222,994 6.53 5.72 167,930 5.72
$13.38 275,525 9.73 13.38 0 0
$17.50 804,188 7.34 17.50 240,042 17.50
$17.75 - $19.38 65,250 8.47 18.68 11,375 18.47
$19.75 5,000 8.61 19.75 1,250 19.75
$22.00 27,500 9.03 22.00 0 0
$24.75 20,000 8.63 24.75 5,000 24.75
$30.50 5,000 9.98 30.50 0 0
--------- ----- -------- -------- -------
$ .76 - $30.50 1,881,740 7.21 $ 11.89 868,772 $ 7.20
=============== ========= ===== ======== ======== =======
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation". Accordingly, compensation expense
for options awarded under the Plans in 1999, 1998 and 1997, has been recognized
using the intrinsic value method.
F-14
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The fair value of options granted prior to the consummation of the Offering was
estimated using the minimum value method and risk-free interest rates and
expected option lives of 6% and seven years, respectively. The minimum value
pricing method was designed to value stock options of non-public companies;
accordingly, the minimum value method assumed zero volatility.
The Black-Scholes model was used to value options granted subsequent to the
Offering using a volatility factor of 50%, estimated option lives of four years,
and a risk-free interest rate of 6% for 1999 and 1998. Management believes that
the assumptions used and the models applied to value the awards yield a
reasonable estimate of the fair value of the grants made under the
circumstances, given the alternatives under SFAS No. 123.
Effective upon the consummation of the Offering, certain restrictions as to the
exercise of options granted under the Company's 1993 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 upon the consummation of the Offering, the
Company recorded a one-time charge for stock-option compensation expense of
approximately $870, relating to the acceleration of the vesting period of
certain of the Company's stock options from seven to four years.
Compensation expense charged to operations using the intrinsic value method
totaled $162, $1,297 (including the one-time charge of $870 referred to above),
and $873 for the years ended December 31, 1999, 1998, and 1997, respectively.
Had the Company recorded compensation expense using the fair value method under
SFAS No. 123, pro forma net income and diluted net income per share for the
years ended December 31 would have been as follows:
PRO FORMA
---------
1999 1998 1997
---- ---- ----
Net income, as reported $22,730 $13,828 $3,564
Net income, under SFAS No. 123 21,511 12,979 3,498
Diluted net income per share, as reported 1.41 .88 .25
Diluted net income per share, under SFAS No. 123 1.33 .83 .25
1997 Employee Stock Purchase Plan
In November 1997, the Board adopted and the stockholders approved the 1997
Employee Stock Purchase Plan (the "Purchase Plan"), which became effective on
February 1, 1999. The Purchase Plan authorizes the issuance of Common Stock to
participating employees. Under the terms of the Purchase Plan, the purchase
price is an amount equal to 85% of the fair market value per share of the Common
Stock on either the first day or the last day of the offering period, whichever
is lower. An aggregate of 225,000 shares of Common Stock has been reserved for
issuance under the Purchase Plan.
9. INCOME TAXES
The provision for income taxes prior to March 6, 1998 was based on the state
income tax obligations of the Company as an S Corporation and was $639 for the
year ended December 31, 1997. Effective with the consummation of the Offering,
the Company's S Corporation election was terminated and the Company began to
account for income taxes as a C Corporation.
F-15
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The 1999 and 1998 provision for income taxes and unaudited 1998 and 1997 pro
forma provision for income taxes consisted of the following:
Years Ended December 31,
(Pro Forma)(pro Forma)
1999 1998 1998 1997
---- ---- ---- ----
Paid or currently payable:
- --------------------------
Federal ................................................ $ 10,373 $ 6,390 $ 7,706 $ 9,214
State .................................................. 1,409 842 766 793
-------- ------- ------- -------
Total current........................................ 11,782 7,232 8,472 10,007
-------- ------- ------- -------
Deferred:
Recognition of deferred tax asset upon termination of
S Corporation election............................... - (4,200) - -
Federal ................................................ 1,983 795 1,054 (2,890)
State................................................... 170 78 105 (154)
-------- ------- ------- -------
Net deferred......................................... 2,153 (3,327) 1,159 (3,044)
-------- ------- ------- -------
Net provision........................................ $ 13,935 $ 3,905 $ 9,631 $ 6,963
======== ======= ======= =======
The components of the deferred taxes at December 31, 1999 and 1998 are as
follows:
1999 1998
---- ----
Current:
- --------
Provisions for doubtful accounts ..................... $ 1,456 $ 2,197
Inventory costs capitalized for tax purposes.......... 519 517
Inventory and sales returns reserves ................. 1,221 1,365
Deductible expenses, primarily employee-benefit
related............................................... 114 421
Other liabilities .................................... (1,319) (1,319)
------- -------
Net deferred tax assets............................ 1,991 3,181
======= =======
Non-Current:
- ------------
Compensation under non-statutory stock option agreements.......... 670 709
Accumulated depreciation ......................................... (2,249) (395)
------- -------
Net deferred tax asset (liability)............................. (1,579) 314
------- -------
Net deferred tax asset............................................ $ 412 $ 3,495
======= =======
The reconciliation of the Company's 1999 and 1998 income tax provision and its
1998 and 1997 unaudited pro forma income tax provision to the statutory federal
tax rate is as follows:
(Pro Forma)(pro Forma)
1999 1998 1998 1997
---- ---- ---- ----
Statutory tax rate..................................................... 35.0% 35.0% 35.0% 35.0%
Recognition of deferred tax asset upon termination of
S Corporation election............................................ - (18.6) - -
1998 S Corporation income not subject to federal income
taxes............................................................. - (2.8) - -
State income taxes, net of federal benefit............................. 2.6 2.6 2.6 2.6
Nondeductible expenses ................................................ 0.2 0.2 0.2 0.2
Other - net ........................................................... 0.2 0.9 0.9 1.2
---- ------ ---- ----
Effective income tax rate......................................... 38.0% 17.3% 38.7% 39.0%
==== ==== ==== ====
10. EMPLOYEE BENEFIT PLAN
The Company has a contributory profit-sharing and employee savings plan covering
all qualified employees. No contributions to the profit-sharing element of the
plan were made by the Company in 1999, 1998 or 1997. The Company made matching
contributions to the employee savings element of the plan of approximately $317
thousand, $361 thousand, and $171 thousand in 1999, 1998 and 1997,respectively.
F-16
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
11. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases certain office facilities from its principal stockholders
under 20-year noncancelable operating leases. The lease agreement for one
facility requires the Company to pay all real estate taxes and insurance
premiums related thereto. The Company also leases several other buildings from
its principal stockholders on a month-to-month basis.
In addition, the Company leases office, warehouse facilities and equipment from
unrelated parties with remaining terms of one to four years.
Future aggregate minimum annual lease payments under these leases at December
31, 1999 are as follows:
Year Ending December 31 Related Parties Others Total
----------------------- --------------- ------ ------
2000........................... $ 151 $2,490 $2,641
2001........................... 151 1,700 1,851
2002........................... 121 1,471 1,592
2003........................... 106 155 261
2004........................... 106 - 106
2004 and thereafter............ 371 - 371
Total rent expense aggregated $1,470, $1,521 and $1,398 for the years ended
December 31, 1999, 1998 and 1997, respectively, under the terms of the leases
described above. Such amounts included $189, $327 and $311 in 1999, 1998 and
1997, respectively, paid to related parties.
Contingencies
The Company is subject to various legal proceedings and claims which have arisen
during the ordinary course of business. In the opinion of management, the
outcome of such matters is not expected to have a material effect on the
Company's financial position, results of operations and cash flows.
12. OTHER RELATED PARTY TRANSACTIONS
Other related-party transactions include the transactions summarized below.
Related parties consist primarily of affiliated companies related to the Company
through common ownership.
Year Ended December 31
----------------------
1999 1998 1997
---- ---- ----
Revenue:
Sales of various products...................... $ 1 $ 13 $ 38
Sales of services to affiliated companies...... 332 - -
Sales of property and equipment:
Net book value................................ - - (14)
Proceeds...................................... - - 16
Costs:
Purchase of services from affiliated
companies..................................... 6 2 1,280
13. 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.
F-17
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 resources and assess the Company's
performance. However, senior management does monitor revenue by platform (PC vs
Mac), sales channel (Inbound Telesales, Corporate Outbound, 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:
Year Ended December 31,
-----------------------
1999 1998 1997
---- ---- ----
Platform
--------
PC and Multi Platform $ 895,412 $587,100 $ 439,286
Mac 161,292 145,270 111,289
---------- -------- ---------
Total $1,056,704 $732,370 $ 550,575
========== ======== =========
Sales Channel
-------------
Corporate Outbound $ 694,924 $390,922 $ 257,215
Inbound Telesales 303,707 312,356 288,113
On-Line Internet 58,073 29,092 5,247
---------- -------- ---------
Total $1,056,704 $732,370 $ 550,575
========== ======== =========
Product Mix
-----------
Computer Systems and Memory $ 502,530 $319,759 $ 232,343
Peripherals 356,216 252,966 188,847
Software 129,944 102,451 86,991
Networking and Communications 68,014 57,194 42,394
---------- -------- ---------
Total $1,056,704 $732,370 $550,575
========== ======== =========
Substantially, all of the Company's net sales in 1999, 1998 and 1997 were made
to customers located in the United States. Shipments to customers located in
foreign countries aggregated less than 2% in 1999, 1998 and 1997. All of the
Company's assets at December 31, 1999 and 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 other
than federal government accounted for more than 1% of total net sales in 1999.
Net sales to the federal government in 1999 were $81.4 million or 7.7% of total
net sales. No single customer (including the federal government) accounted for
more than 1% of total net sales in 1998 and 1997.
F-18
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
14.SELECTED UNAUDITED QUARTERLY FINANCIAL RESULTS
The following table sets forth certain unaudited quarterly data of the Company
for each of the quarters since January 1998. This information has been prepared
on the same basis as the annual financial statements and all necessary
adjustments, consisting only of normal recurring adjustments, have been included
in the amounts stated below to present fairly the selected quarterly information
when read in conjunction with the annual financial statements and the notes
thereto included elsewhere in this document. The quarterly operating results are
not necessarily indicative of future results of operations. See "Factors That
May Affect Future Results and Financial Condition - Historical Net Losses;
Variability of Quarterly Results.''
Quarters Ended
-------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999
-------------------------------------------------------
(in thousands, except per share data)
Net sales $ 224,979 $ 231,833 $ 282,103 $ 317,789
Cost of sales 197,913 204,034 247,651 277,760
--------- --------- ---------- ----------
Gross profit 27,066 27,799 34,452 40,029
Selling, general and administrative expenses 19,763 20,040 24,333 27,269
--------- --------- ---------- ----------
Income from operations 7,303 7,759 10,119 12,760
Interest expense (266) (276) (449) (401)
Other, net 94 47 32 (57)
--------- --------- ---------- ----------
Income before income taxes 7,131 7,530 9,702 12,302
Income tax provision /(1)/ (2,710) (2,862) (3,687) (4,676)
--------- --------- ---------- ----------
Net Income $ 4,421 $ 4,668 $ 6,015 $ 7,626
========= ========= ========== ==========
Weighted average common shares outstanding:
Basic $ 15,622 $ 15,627 $ 15,651 $ 15,697
========= ========= ========== ==========
Diluted $ 16,068 $ 16,061 $ 16,078 $ 16,455
========= ========= ========== ==========
Earnings per common share:
Basic $ .28 $ .30 $ .39 $ .48
========= ========= ========== ==========
Diluted $ .28 $ .29 $ .37 $ .47
========= ========= ========== ==========
Quarters Ended
-------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31
1998 1998 1998 1998
-------------------------------------------------------
(in thousands, except per share data)
Net sales $ 168,643 $ 174,349 $ 169,089 $ 220,289
Cost of sales 146,694 151,768 147,837 192,797
--------- --------- ---------- ----------
Gross profit 21,949 22,581 21,252 27,492
Selling, general and administrative expenses 16,858 16,042 16,317 19,304
Additional stockholder/officer compensation 2,354 - - -
--------- --------- ---------- ----------
Income from operations 2,737 6,539 4,935 8,188
Interest expense (206) (51) (10) (148)
Other, net 86 213 233 33
--------- --------- ---------- ----------
Income before income taxes 2,617 6,701 5,158 8,073
Income tax benefit (provision) /(1)/ 3,788 (2,613) (2,012) (3,068)
--------- --------- ---------- ----------
Net Income $ 6,405 $ 4,088 $ 3,146 $ 5,005
========= ========= ========== ==========
Weighted average common shares outstanding:
Basic 15,414 15,443 15,548
========= ========== ==========
Diluted 15,938 16,000 15,963
========= ========== ==========
Earnings per common share:
Basic $ .27 $ .20 $ .33
========= ========== ==========
Diluted $ .26 $ .20 $ .32
========= ========== ==========
F-19
PC CONNECTION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Pro forma data:
Historical income before income taxes $ 2,617
Pro forma income taxes (1,020)
-------
Pro forma net income /(2)/ $ 1,597
=======
Pro forma weighted average shares outstanding:
Basic 14,236
======
Diluted 14,835
======
Pro forma earnings per share:
Basic $ .11
=======
Diluted $ .11
=======
(1) For all periods prior to March 6, 1998 described herein, the Company elected
to be treated as an S Corporation under Subchapter S of the Code, and
applicable state laws. Effective March 6, 1998, the closing of the Company's
initial public 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. For the
quarter ended March 31, 1998, the income tax provision includes a $4.2
million 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.
(2) Pro forma net income is determined by (i) by eliminating the actual income
tax provision and adding a provision for Federal and state income taxes that
would have been payable by the Company if taxed under Subchapter C of the
Code for all periods prior to March 6, 1998.
15.SUBSEQUENT EVENTS
On January 1, 2000, the Company announced a new holding company structure to
support PC Connection's future growth and plans to expand its current business
lines through internal growth and potential acquisitions.
Outstanding shares of common stock representing interests in PC Connection prior
to the holding company formation were converted into shares of the new holding
company on a one-for-one basis through a non-taxable transaction. Common stock
shares of the new holding company were listed on the Nasdaq National Market
under the symbol, "PCCC", the same exchange and symbol used by the predecessor
company. The new shares hold the same voting power that shares of the
predecessor company held. No additional capital stock was issued as part of the
transaction. The directors and officers of the predecessor company serve as the
directors and officers of the new holding company.
On January 4, 2000, the Company acquired Merisel Americas, Inc. call center
operation in Marlborough, Massachusetts for approximately $2.2 million. PC
Connection offered employment opportunities to more than 100 of Merisel's
highly-trained telesales account managers and support staff to join PC
Connection's corporate outbound sales organization. Substantially, all such
employees accepted employment with PC Connection.
F-20
PART IV
- ------------------------------------------------------------------------------
Item 14. Exhibits, Consolidated Financial Statements, Schedule, and Reports on
Form 8-K
- ------------------------------------------------------------------------------
(a) List of Documents Filed as Part of This Report:
(1) Consolidated Financial Statements
The consolidated financial statements listed below are included in this
document.
Consolidated Financial Statements Page References
--------------------------------- ---------------
Report of Management....................................... F-2
Independent Auditors' Report............................... F-3
Consolidated Balance Sheets................................ F-4
Consolidated Statements of Income.......................... F-5
Consolidated Statement of Changes in Stockholders'
Equity..................................................... F-6
Consolidated Statements of Cash Flows...................... F-7
Notes to Consolidated Financial Statements................. F-8
(2) Consolidated Financial Statement Schedule:
The following Consolidated Financial Statement Schedule of the Company
as set forth below is filed with this report:
Schedule Page Reference
-------- --------------
Schedule II - Valuation and Qualifying Accounts.........S-1
(3) Supplementary Data
Not applicable.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K on January 3, 2000, due
to the reorganization of the Company.
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated herein by
reference to other filings.
EXHIBIT INDEX
Exhibit Page Reference
------- --------------
*3.2 Amended and Restated Certificate of Incorporation of Registrant.
*3.4 Bylaws of Registrant.
*4.1 Form of specimen certificate for shares of Common Stock, $0.01 par
value per share, of the Registrant.
*9.1 Form of 1998 PC Connection Voting Trust Agreement among the
Registrant, Patricia Gallup individually and as a trustee, and David
Hall individually and as trustee.
*10.1 1993 Incentive and Non-Statutory Stock Option Plan, as amended.
*10.2 1997 Stock Incentive Plan.
*10.3 Lease between the Registrant and Miller-Valentine Partners, dated
September 24, 1990, as amended, for property located at 2870 Old
State Route 73, Wilmington, Ohio.
*10.4 Lease between the Registrant and Lower Bellbrook Company, dated
September 26, 1997, for property located at 643-651 Lower Bellbrook
Avenue, Xenia, Ohio.
*10.5 Lease between the Registrant and Gallup & Hall partnership, dated May
1, 1997, for property located at 442 Marlboro Street, Keene, New
Hampshire.
*10.6 Lease between the Registrant and Gallup & Hall partnership, dated June
1, 1987, as amended, for property located in Marlow, New
Hampshire.
*10.7 Lease between the Registrant and Gallup & Hall partnership, dated
July 22, 1998, for property located at 450 Marlboro Street, Keene,
New Hampshire.
*10.9 Lease between the Registrant and Century Park, LLC, dated October
1, 1997 for property located at Route 111, Hudson, New Hampshire.
*10.10 Amended and Restated Lease between the Registrant and G&H Post,
LLC, dated December 29, 1997 for property located at Route 101A,
Merrimack, New Hampshire.
*10.11 Sublease between the Registrant and ABX Air Inc., dated June 7,
1995, for property located at 2870 Old State Route 73, Wilmington,
Ohio.
*10.12 Employment Agreement between the Registrant and Wayne L. Wilson,
dated August 16, 1995.
*10.13 Employment Agreement between the Registrant and Robert F. Wilkins,
dated December 23, 1995.
*10.15 Letter Agreement between the Registrant and Airborne Freight
Corporation D/B/A "Airborne Express," dated April 30, 1990, as
amended.
*10.16 Agreement between the Registrant and Ingram Micro, Inc., dated
October 30, 1997, as amended.
*10.18 Employment Agreement, dated as of January 1, 1998, between the
Registrant and Patricia Gallup.
*10.19 Employment Agreement, dated as of January 1, 1998, between the
Registrant and David Hall.
*10.20 Form of Registration Rights Agreement among the Registrant,
Patricia Gallup, David Hall and the 1998 PC Connection Voting
Trust.
**10.21 Amendment No. 1 to Amended and Restated Lease between the
Registrant and G&H Post, LLC, dated December 29, 1998 for
property located at Route 101A,Merrimack, New Hampshire.
**10.22 Lease between Registrant and Dover Mills, LLC, dated August 1,
1998 for property located at Cocheco Falls Millworks, Dover,
New Hampshire.
**10.23 Amended Lease Agreement between the Registrant and Dover Mills,
LLC, dated August 1, 1998.
**10.24 Employment Agreement between the Registrant and John L. Bomba,
dated March 28,1997.
**10.25 Employment Agreement between the Registrant and Mark A. Gavin,
dated February 5, 1998.
(1)10.26 Agreement for Wholesale Financing, dated as of March 25, 1998,
between the Registrant and Deutsche Financial Services
Corporation.
(1)10.27 Amendment to Agreement for Wholesale Financing, dated as of
March 25, 1998, between the Registrant and Deutsche Financial
Services Corporation.
(1)10.28 Amendment to Agreement for Wholesale Financing, dated as of
November 5, 1999, between the Registrant and Deutsche Financial
Services Corporation.
(1)10.29 Amendment to Agreement for Wholesale Financing, dated as of
February 25, 2000 between the Registrant and Deutsche Financial
Services Corporation.
(1)10.30 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc. in connection with the Amendment to
Agreement for Wholesale Financing, dated as of February 25,
2000, between the Registrant and Deutsche Financial Services
Corporation.
(1)10.31 Agreement for Inventory Financing, dated as of August 17, 1999,
between the Registrant and IBM Credit Corporation.
(1)10.32 Amendment to Agreement for Inventory Financing, dated as of
February 25, 2000, between the Registrant and IBM Credit
Corporation.
(1)10.33 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc., PC Connection Sales of Massachusetts, Inc.
Merrimack Services Corp. and ComTeq Federal, Inc., in connection
with the Amendment to Agreement for Inventory Financing, dated
as of February 25, 2000, between the Registrant and IBM Credit
Corporation.
(1)10.34 Agreement for Wholesale Financing, dated as of October 12, 1993,
between ComTeq Federal, Inc. and IBM Credit Corporation.
(1)10.35 Amendment to Agreement for Wholesale Financing, dated as of December
23, 1999, between ComTeq Federal, Inc. and IBM Credit Corporation.
(1)10.36 Amendment to Addendum to Agreement for Wholesale Financing, dated as
of December 23, 1999, between ComTeq Federal, Inc. and IBM Credit
Corporation.
(1)10.37 Amendment to Agreement for Wholesale Financing, dated as of February
25, 2000, between ComTeq Federal, Inc. and IBM Credit Corporation.
(1)10.38 Guaranty, dated as of February 25, 2000, entered into by the
Registrant, PC Connection, Inc., PC Connection Sales of
Massachusetts, Inc. and Merrimack Services Corp., in connection with
the Amendment to Agreement for Wholesale Financing, dated as of
February 25, 2000, between ComTeq Federal, Inc. and IBM Credit
Corporation.
(1)10.39 Agreement for Wholesale Financing, dated as of February 25, 2000,
between ComTeq Federal, Inc. and Deutsche Financial Services
Corporation.
(1)10.40 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc. in connection with the Agreement for Wholesale
Financing, dated as of February 25, 2000, between ComTeq Federal,
Inc. and Deutsche Financial Services Corporation.
(1)10.41 Assignment of Lease Agreements, dated as of December 13, 1999,
between Micro Warehouse, Inc. (assignor) and the Registrant
(assignee).
(1)10.42 Amended and Restated Credit Agreement, dated February 25, 2000,
between PC Connection, Inc., the Lenders Party hereto and Citizens
Bank of Massachusetts.
***23.1 Consent of Deloitte & Touche LLP
****23.2 Consent of Deloitte & Touche LLP
23.3 Consent of Deloitte & Touche LLP
(1)27.1 Financial Data Schedule.
- --------------------
* Incorporated by reference from the exhibits filed with the Company's
registration statement (333-41171) on Form S-1 filed under the Securities
Act of 1933.
** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K, File Number 0-23827, filed on March 31, 1999.
*** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K, File Number 0-23827, filed on March 30, 2000.
**** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K Amendment No. 2, File Number 0-23827, filed on April
5, 2000.
(1) Previously filed.
Exhibit 23.3
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in the Registration Statements of
PC Connection, Inc. on Form S-8 (Nos. 333-69981, 333-50847, 333-50845, 333-83943
and 333-40172) of our report dated January 26, 2000, appearing in the Annual
Report on Form 10-K/A Amendment No. 3 of PC Connection, Inc. for the year ended
December 31, 1999.
Boston, Massachusetts
July 28, 2000
