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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(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, 1998
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)
Registrant's telephone number, including area code (603) 423-2000
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__________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 par value, Listed on NASDAQ
Securities registered pursuant to Section 12(g) of the Act: Common Stock
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 18, 1999, was
$49,347,000. 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 18,
1999 was 15,624,856.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 1998 Annual Meeting of
Shareholders for the fiscal year ended December 31, 1998, 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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PC CONNECTION, INC.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Page
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PART I
ITEM 1. Business.............................................................. 2
ITEM 2. Properties............................................................ 9
ITEM 3. Legal Proceedings..................................................... 9
ITEM 4. Submission of Matters to a Vote of Security Holders................... 9
PART II
ITEM 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.............................................................. 10
ITEM 6. Selected Financial and Operating Data................................ 11
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 12
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk............ 24
ITEM 8. Financial Statements and Supplementary Data.......................... 25
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................. 25
PART III
ITEM 10. Directors and Executive Officers of the Registrant................... 25
ITEM 11. Executive Compensation............................................... 25
ITEM 12. Security Ownership of Certain Beneficial Owners and Management....... 25
ITEM 13. Certain Relationships and Related Transactions....................... 25
PART IV
ITEM 14. Exhibits, Financial Statements, and Reports on Form 8-K............... 26
SIGNATURES....................................................................... 28
1
PART I
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Item 1. Business
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This section 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 in Item 7 "Management's Discussion and
Analysis of Financial Conditions and Results of Operations". 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,
continued sales of Mac products, competitive risks, pricing risks, Year 2000
compliance issues, 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 Securities and Exchange Commission
("SEC").
GENERAL
PC Connection, Inc., a Delaware corporation ("PC Connection" or "the Company"),
is a direct marketer of brand-name personal computers and related peripherals,
software, accessories and networking products. The Company's primary target
customers are small and medium-sized businesses ("SMBs") comprised of 20 to
1,000 employees. PC Connection sells its products through a combination of
targeted direct mail catalogs, outbound telemarketing, its Internet Web site and
advertisements on the Internet and in selected computer magazines. The Company
offers a broad selection of approximately 25,000 products targeted for business
use at competitive prices, including products from Compaq, Hewlett-Packard,
Toshiba, IBM, Microsoft, Sony, Acer, Fujitsu, Canon, Iomega and Apple. Net sales
of Microsoft Windows or MS-DOS based personal computers ("PCs") and compatible
products were approximately 80% of net sales in 1998. The Company's most
frequently ordered products are carried in inventory and are typically shipped
to customers the same day that the order is received.
Since its founding in 1982, the Company has focused on serving customer needs by
providing innovative, reliable and timely customer service and technical
support, and offering an extensive assortment of branded products, through
knowledgeable, well-trained sales and support teams. The effectiveness of this
strategy is reflected in the recognition accorded the Company, including the
Company's receipt of the PC World "World Class Award for Best Mail-Order
Company" in 1997, as voted by its readers, for the seventh time in the past nine
years, and receipt of the highest ranking of only two direct resellers included
in the "100 Most Influential Companies in the Computer Industry" by PC Magazine
in 1997 and 1998.
The Company believes that its consistent customer focus has also resulted in the
development of strong brand name recognition and a broad and loyal customer
base. At December 31 1998, the Company's mailing list consisted of approximately
2,300,000 customers and potential customers, of which approximately 680,000 had
purchased products from the Company within the last twelve months. Approximately
68% of the Company's net sales in the year ended December 31, 1998 were made to
customers who had previously purchased products from the Company. The Company
believes it has also developed strong relationships with vendors, resulting in
favorable product allocations and marketing assistance.
Commencing in late 1995, the Company significantly increased its business-to-
business marketing efforts, targeting SMBs, a rapidly growing sector of the
personal computer market that the Company believes is particularly receptive to
purchases from direct marketers. To service this growing part of its business
more effectively, the Company has increased the number of its outbound
telemarketing account managers from 155 at December 31, 1997 to 200 at December
31, 1998. This growth includes 90 new account managers with less than 12 months
of outbound telemarketing experience with the Company.
The Company's two major catalogs are PC Connection(R), focused on PCs and
compatible products, and MacConnection(R), focused on Apple Macintosh personal
computers ("Macs") and compatible products. With colorful
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illustrations, concise product descriptions, relevant technical information,
along with customer service benefits and toll-free telephone numbers for
ordering, the Company's catalogs are recognized as a leading source for personal
computer hardware, software and other related products. The Company distributed
approximately 42 million catalogs during the year ended December 31, 1998.
The Company also markets its products and services through its Internet Web
sites, www.pcconnection.com and www.macconnection.com which provide customers
and prospective customers with Company and product information and enables
customers to place electronic orders for all of the Company's products. Internet
sales processed directly online during the fourth quarter of 1998 were $10.6
million, or 5% of that quarter's net sales, representing a 68% sequential
increase over the third quarter of 1998. Online sales in the fourth quarter of
1998 increased 205% over the comparable quarter in 1997. For the full year 1998,
these sales were $29.1 million, or 4% of net sales, compared to less than 1% in
1997. These results represent a 455% increase in annual Internet sales over
1997.
Fourth quarter 1998 sales sourced from the Company's web site, including orders
processed online and web-generated phone orders, were approximately $23.0
million, exceeding 10% of net sales and representing a sequential increase of
65% over the third quarter of 1998. For the full year 1998, this sales channel
exceeded 8.5% of net sales or approximately $62.7 million, compared to
approximately 3.5% of net sales or approximately $19.0 million for the full year
of 1997.
The Company believes that the reason its e-commerce business is growing so
rapidly is that it offers customers the advanced tools they need to quickly make
educated purchase decisions. Working closely with vendors, the Company believes
it is able to provide one of the broadest, leading-edge technology selections in
the industry. By leveraging its merchandising expertise, catalog mailings, and
established infrastructure, the Company has built an Internet business that has
been profitable from the start -- and one that complements all other sales
channels.
INDUSTRY BACKGROUND
According to industry data published by Merrin in May 1997, United States sales
of personal computers and related products were $77.8 billion in 1996 and are
expected to be $138.2 billion in 2000, representing a compound annual growth
rate of 15.4%. The Company believes that the direct marketing channel will be
among the fastest growing distribution channels for the domestic personal
computer and related products industry. As a leading participant in the direct
marketing channel, the Company believes it is well positioned to capitalize on
the expected growth in the industry.
The Company believes that sales of personal computers and related products have
increased principally as a result of (i) technological advances leading to
significant improvements in performance, functionality and ease of use; (ii)
lower prices and improved price/performance made possible by technological
advances and driven by intense competition among manufacturers, retailers and
resellers; (iii) increased dependence upon PCs by businesses, educational
institutions and governments; and (iv) the emergence of industry standards and
component commonality. The Company believes that the higher projected growth for
the direct marketing channel is primarily based on (i) increased user
familiarity with PCs, coupled with the emergence of industry standards and
component commonality, and the resultant increase in customer comfort with
purchasing products without the need to "touch and feel" them, and (ii)
broader product offerings, lower prices and greater purchasing convenience that
direct marketers generally provide over traditional retail stores and local
dealers.
Users of personal computers range from large corporate entities focused on
business applications to individual consumers focused primarily on personal
productivity, education and entertainment applications. Historically, large
corporate resellers have served the needs of FORTUNE 1000 companies and
retailers have competed to serve the consumer market. SMBs, the Company's core
target customers, are being served by a wide range of suppliers, including
direct marketers, large retailers, and small, independent value added resellers
(''VARs'') and local dealerships. The Company believes that the direct field
sales model used by large resellers is not an efficient method of reaching SMBs,
and that VARs, local dealerships and retailers are unable to match the high
level of customer service, extensive array of products, low prices and
efficiencies afforded to SMBs by direct marketers. Intense competition for
market share has led manufacturers of PCs and related products to use all
available channels to distribute products, including direct marketers. Although
certain manufacturers that have traditionally used resellers to distribute their
products have established or attempted to establish their own direct marketing
operations, including sales through the Internet, to the Company's knowledge,
only one has replaced its traditional indirect selling channels as the principal
means of distribution. Accordingly, the Company believes these manufacturers
will continue to provide favorable product allocations and marketing support to
third-party direct marketers, such as the Company
3
The Company believes new entrants to the direct marketing channel must overcome
a number of significant barriers to entry, including the time and resources
required to build a customer base of meaningful size, quality and responsiveness
for cost-effective circulation; costs of developing the information and
operating infrastructure required by direct marketers; the advantages enjoyed by
larger and more established competitors in terms of purchasing and operating
efficiencies; the difficulty of building relationships with manufacturers to
achieve favorable product allocations, attractive pricing terms and cooperative
advertising funds; and the difficulty of identifying and recruiting management
personnel with significant direct marketing experience in the industry.
BUSINESS STRATEGIES
The Company's objective is to become the leading supplier of personal computers
and related products and services to its customers. The key elements of the
Company's business strategies include:
. AWARD-WINNING CUSTOMER SERVICE BEFORE, DURING AND AFTER THE SALE. The
Company believes that it has earned a reputation for providing superior
customer service by consistently focusing on customer needs and service
innovation. The Company has won PC World's ''World Class Award for Best
Mail Order Company'' in seven out of the last nine years. The Company
delivers value to its customers through high quality service and technical
support provided by knowledgeable, well-trained personnel; efficient and
innovative delivery programs; in-house servi ce capabilities; competitive
prices; and reasonable return policies.
. STRONG BRAND NAME AND CUSTOMER FRANCHISE. Since its founding in 1982, the
Company has built a strong brand name and customer franchise. In July 1998
and 1997, the Company was one of only two direct resellers included in the
''100 Most Influential Companies in the Computer Industry'' by PC Magazine.
The Company's mailing list includes approximately 2,300,000 names, of which
approximately 680,000 have purchased products from the Company during the
last 12 months.
. BROAD PRODUCT SELECTION AT COMPETITIVE PRICES. The Company offers its
customers a wide assortment of personal computers and related products at
competitive price points. The Company's merchandising programs feature
products that provide customers with aggressive price/performance and the
convenience of one-stop shopping for their personal computer and related
needs.
. LONG-STANDING VENDOR RELATIONSHIPS. The Company has a history of strong
relationships with vendors, being among the first direct marketers
qualified by manufacturers to market systems to end users. The Company
provides its vendors with information concerning customer preferences and
an efficient channel for the advertising and distribution of their
products.
GROWTH STRATEGIES
The Company's growth strategies are to increase penetration of its existing
customer base, broaden its product offerings and expand its customer base. The
key elements of its strategies include:
. INCREASE OUTBOUND TELEMARKETING. The Company plans to continue to increase
significantly the number of its corporate outbound account managers and
assign them to a higher percentage of the Company's customers. Outbound
account managers focus exclusively on serving specifically assigned
customers and seek to develop a close relationship with those customers by
identifying and responding to their needs for personal computers and
related products.
. EXPAND PRODUCT OFFERINGS. The Company continually evaluates personal
computers and related products focused on business users, adding new
products as they become available or in response to customer demand. The
Company works closely with vendors to identify and source first-to-market
product offerings at aggressive price points, and believes that expansion
of its corporate outbound marketing program will enhance its access to such
product offerings.
. TARGET CUSTOMER SEGMENTS. Through targeted mailings, the Company seeks to
expand the number of its active customers and generate additional sales
from its existing customers on a cost-effective basis. The Company has
developed specialty catalogs, as well as standard catalogs with special
cover pages, featuring product offerings
4
designed to address the needs of specific customer segments, including new
product inserts targeted to purchasers of graphics, server and networking
products.
. EXPAND ELECTRONIC COMMERCE CHANNEL. The Company's Internet Web-based
catalog provides detailed product descriptions, product search capabilities
and on-line order processing. The Company believes that an increasing
number of customers and potential new customers will elect to shop
electronically in the future and therefore it plans additional investments
to further improve the on-line sales capabilities, customer service and
product information and support available on its Internet Web site.
SERVICE AND SUPPORT
Since its founding in 1982, the Company's primary objective has been to provide
products that meet the demands and needs of customers and to supplement those
products with up-to-date product information and excellent customer service and
support. The Company believes that offering its customers superior value,
through a combination of product knowledge, consistent and reliable service and
leading products at competitive prices, differentiates it from other direct
marketers and has become the foundation for developing a broad and loyal
customer base. The Company has introduced programs such as Toll-Free Technical
Support in 1982, the Everything Overnight(R) delivery program in 1988, Money
Back Guarantees in 1989, One-Minute Mail Order(R) in 1991 and its On-line
Superstore in 1997.
The Company invests in training programs for its service and support personnel,
with an emphasis on putting customer needs and service first. Customer service
representatives are available 24 hours a day, seven days a week to handle
orders, product information and general inquiries (including the most frequently
asked technical support questions).
The Company provides toll-free technical support from 9 a.m. through 5 p.m.,
eastern time, Monday through Friday. Product support technicians assist callers
with questions concerning compatibility, installation, determination of defects
and more difficult questions of product use. The product support technicians
authorize customers to return defective or incompatible products to either the
manufacturer or to the Company for warranty service. In-house technicians are
authorized for both warranty and non-warranty repair on most major systems and
hardware products.
Using the Company's customized information system, the Company, upon receipt of
customer orders, sends them to its distribution center for processing
immediately after they are credit approved. Through its Everything Overnight(R)
service, the Company guarantees that all orders accepted up until 2:45 a.m.
(until midnight on most custom-configured systems) will be shipped for overnight
delivery via Airborne Express. The Company configures approximately half of the
computer systems it sells. Configuration typically consists of the installation
of memory, accessories and/or software.
MARKETING AND SALES
The Company sells its products through the direct marketing channel, primarily
to SMBs. The Company's marketing objectives are to be the primary supplier of
personal computers and related products to its existing customers and to expand
its customer base. The Company employs multiple marketing approaches to reach
existing and prospective customers, including outbound telemarketing, catalogs
and inbound telesales, Web and print media advertising, and specialty marketing
programs. All of its marketing approaches emphasize the Company's broad product
offerings, fast delivery, customer support, competitive pricing and multiple
payment options.
The Company believes that its ability to establish and maintain long-term
customer relationships and to encourage repeat purchases is largely dependent on
the strength of its telemarketing personnel and programs. Because its customers'
primary contact with the Company is through its telemarketers, the Company is
committed to maintaining a qualified, knowledgeable and motivated sales staff
with its principal focus on customer service.
Outbound Telemarketing. The Company seeks to build loyal relationships with its
potential high-volume customers by assigning them to individual account
managers. The Company believes that customers respond favorably to a one-on-one
relationship with personalized, well-trained account managers. Once established,
these one-on-one relationships are maintained and enhanced through frequent
telecommunications and targeted catalogs and other marketing materials designed
to meet each customer's specific computing needs.
5
Account managers focus exclusively on their managed accounts and on outbound
sales calls to prospective customers. The Company generally recruits account
managers from its inbound telemarketing staff and from other sales
organizations. All account managers must successfully complete a one-month
training program, which includes instruction in the Company's product offerings
and order management systems, as well as selling skills and account management.
Thereafter, new account managers are assigned to sales teams where they receive
intensive coaching and supervision by experienced supervisors, and periodic
refresher training from the sales training staff. Additional training and
product education programs are provided continuously through vendor supported
programs. The Company pays its account managers a base annual salary plus
incentive compensation which is tied to sales volume and gross profit dollars
produced. The Company imposes specific increases in sales targets for incentive
pay. Account managers historically have significantly increased productivity
after approximately 12 months of training and experience. At December 31, 1998,
the Company employed 200 account managers, including 90 with less than 12 months
of outbound telemarketing experience with the Company.
Catalogs and Inbound Telesales. The Company's two principal catalogs are PC
Connection(R) for the PC market and MacConnection(R) for the Mac market. The
Company publishes twelve editions of each of these catalogs annually. The
Company distributes catalogs to purchasers on its in-house mailing list as well
as to other prospective customers. It sends its two principal catalogs to its
best customers twice each month. The initial mailing each month, labeled an
''early edition,'' is sent simultaneously to the best customers throughout the
United States and features special offers, such as first-to-market product
offerings, highlighted on the cover. The Company also includes a catalog with
each order shipped.
In addition, the Company mails specialty catalogs or customized versions of its
catalogs to selected customers. The Company distributes specialty catalogs to
educational and governmental customers and prospects on a periodic basis. The
Company also distributes its monthly catalogs customized with special covers and
inserts, offering a wider assortment of special offers on products in specific
areas (such as graphics, server/netcom and mobile computing) or for specific
customers (such as developers). These customized catalogs are distributed to
targeted customers included in the Company's customer database using past
identification or purchase history, as well as to outside mailing lists.
Each catalog is printed with full-color photographs, detailed product
descriptions and manufacturer specifications. The catalogs are primarily created
by in-house designers and production artists on a computer-based desktop
publishing system. The in-house preparation of most portions of the catalog
expedites the production process, providing for greater flexibility and
creativity in catalog production, allowing for last-minute changes in pricing
and format, and resulting in significant cost savings. After completion of the
design and preparation, the catalogs are outsourced for printing by commercial
printers.
The Company employs inbound sales representatives to answer customer telephone
calls generated by the Company's catalog, magazine and other advertising
programs and to assist customers in purchasing decisions, process product orders
and respond to customer inquiries on order status, product pricing and
availability. Since 1995, the Company has increased the training of inbound
telemarketing personnel and provided incentive compensation based upon sales
productivity. The Company employs a flexible staffing model which allows it to
maintain excellent customer service during periods of peak demand while
maintaining an efficient cost structure. The Company regularly monitors calls
for quality assurance purposes. It has been a pioneer in using caller
identification for the instant retrieval of customer records. Employing
proprietary information systems, sales representatives can quickly access
customer records which detail purchase history and billing and shipping
information, expediting the ordering process. In addition to receiving orders
through the Company's toll-free numbers, orders are also received via fax, mail
and electronic mail.
Advertising. The Company has historically advertised in selected personal
computer and trade magazines, such as PC Magazine, PC World and Macworld. These
advertisements provide product descriptions, manufacturers' specifications and
pricing information, and emphasize the Company's service and support features.
Additionally, the PC Connection(R) logo and telephone number are included in
promotions by selected manufacturers.
www.pcconnection.com. In November 1996, the Company launched an Internet Web
site, including a complete product catalog. In July 1997, the Company began
accepting electronic orders through its Internet Web site. Product descriptions
and prices of all products are provided on-line, with full, updated information
for over 12,000 items and on screen images available for over 6,000 items. The
Company offers, and continuously updates, selected product offerings and other
special buys. The Company believes that in the future its Internet Web site will
be an important sales source and communication tool for improving customer
service.
6
Specialty Marketing. The Company's specialty marketing activities include
direct mail, other inbound and outbound telemarketing services, bulletin board
services, ''fax on demand'' services, package inserts, fax broadcasts and
electronic mail. The Company also markets call-answering and fulfillment
services to certain of its product vendors such as Iomega Corporation.
Customers. The Company currently maintains an extensive database of customers
and prospects aggregating approximately 2,300,000 names. During the year ended
December 31, 1998, the Company received orders from approximately 680,000
customers. Approximately 68% of the Company's net sales in the year ended
December 31, 1998 were made to customers who had previously purchased products
from the Company.
PRODUCTS AND MERCHANDISING
The Company continuously focuses on expanding the breadth of its product
offerings. The Company currently offers approximately 25,000 personal computer
products designed for business applications from over 1,000 manufacturers,
including hardware and peripherals, accessories, networking products and
software. The Company offers both PCs and Macs and related products. In 1998,
sales of PCs and related products were approximately 80% of the Company's net
sales. The Company selects the products that it sells based upon their
technology and effectiveness, market demand, product features, quality, price,
margins and warranties. As part of its merchandising strategy, the Company also
offers new types of products related to PCs, such as digital cameras.
Computer systems/memory is the fastest growing product category, representing
43.7% of net sales in the year ended December 31, 1998, up from 42.2% and 34.8%
of net sales in the years ended December 31, 1997 and 1996, respectively. The
growth in system sales has been driven primarily by increased outbound sales
efforts to business customers and the aggressive sourcing and merchandising of
new computer systems lines and products.
The following table sets forth the Company's percentage of net sales (in
dollars) of computer systems/memory, peripherals, software, and networking and
communications products during the years ended December 31, 1998, 1997 and 1996.
PERCENTAGE OF NET SALES
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Year Ended December 31,
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PRODUCT CATEGORIES 1998 1997 1996
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Computer Systems/Memory........................ 43.7% 42.2% 34.8%
Peripherals.................................... 34.5 34.3 38.0
Software....................................... 14.0 15.8 17.6
Networking and Communications . 7.8 7.7 9.6
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Total....................................... 100.0% 100.0% 100.0%
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The Company offers a limited 30-day money back guarantee for most unopened
products and selected opened products, although selected products are subject to
restocking fees. Substantially all of the products marketed by the Company are
warranted by the manufacturer. The Company generally accepts returns directly
from the customer and then either credits the customer's account or ships the
customer a similar product from the Company's inventory.
PURCHASING AND VENDOR RELATIONS
For the year ended December 31, 1998, the Company purchased approximately 62% of
its products directly from manufacturers and the balance from distributors and
aggregators, all of which shipped products directly to the Company's
distribution facility in Wilmington, Ohio. During the years ended December 31,
1998 and 1997, product purchases from Ingram Micro, the Company's largest
vendor, accounted for approximately 20% and 28%, respectively, of the Company's
total product purchases. No other vendor accounted for more than 10% of the
Company's total product purchases. The Company believes that alternative sources
for products obtained from Ingram Micro are available.
Many product suppliers reimburse the Company for advertisements or other
cooperative marketing programs in the Company's catalogs or Company
advertisements in personal computer magazines that feature a manufacturer's
product. Reimbursements may be in the form of discounts, advertising allowances
and/or rebates. The Company also receives reimbursements from certain vendors
based upon the volume of purchases or sales of the vendors' products by the
Company. Historically, the Company received price protection from its vendors on
a majority of the products it sold.
7
Protection takes the form of rebates or credits against future purchases. The
Company may participate in the future in end-of-life-cycle and other special
purchases which may not be eligible for price protection.
The Company believes that it has excellent relationships with vendors, generally
pays vendors within stated terms and takes advantage of all appropriate
discounts. The Company believes that because of its volume purchases it is able
to obtain product pricing and terms that are competitive with those available to
other major direct marketers. Although brand names and individual product
offerings are important to the Company's business, the Company believes that
competitive sources of supply are available in substantially all of the
merchandise categories carried by the Company.
DISTRIBUTION
At its approximately 140,000 square foot distribution and fulfillment complex in
Wilmington, Ohio, the Company receives and ships inventory, configures computer
systems and processes returned products. Orders are transmitted electronically
from the Company's New Hampshire sales facilities to its Wilmington distribution
center after credit approval, where packing documentation is printed
automatically and order fulfillment takes place. Through its Everything
Overnight(R) service, the Company guarantees that all orders accepted up until
2:45 a.m. (until midnight on custom-configured systems) will be shipped for
overnight delivery via Airborne Express. It ships approximately 75% of its
orders through Airborne Express. Upon request, orders may also be shipped by
other common carriers.
MANAGEMENT INFORMATION SYSTEMS
The Company uses management information systems, principally comprised of
applications software running on IBM AS/400 and RS6000 computers and Microsoft
NT-based servers, which the Company has customized for its use. These systems
permit centralized management of key functions, including order taking and
processing, inventory and accounts receivable management, purchasing, sales and
distribution, and the preparation of daily operating control reports on key
aspects of the business. The Company also operates advanced telecommunications
equipment to support its sales and customer service operations. Key elements of
the telecommunications systems are integrated with the Company's computer
systems to provide timely customer information to sales and service
representatives, and to facilitate the preparation of operating and performance
data. The Company believes that its customized information systems enable the
Company to improve its productivity, ship customer orders on a same-day basis,
respond quickly to changes in its industry and provide high levels of customer
service.
The Company's success is dependent in large part on the accuracy and proper use
of its information systems, including its telephone systems, to manage its
inventory and accounts receivable collections, to purchase, sell and ship its
products efficiently and on a timely basis, and to maintain cost-efficient
operations. The Company expects to continually upgrade its information systems
to more effectively manage its operations and customer database. The Company
recently replaced its order management and fulfillment software with new
software and converted its principal computer equipment to new IBM AS400
platform systems, both of which are better suited to the Company's expected
scale of operations and are designed to be Year 2000 compliant.
COMPETITION
The direct marketing and sale of personal computers and related products is
highly competitive. PC Connection competes with other direct marketers of
personal computers and related products, including CDW Computer Centers, Inc.,
Insight Enterprises, Inc. and Micro Warehouse, Inc. The Company also competes
with certain product manufacturers that sell directly to customers, such as Dell
Computer Corporation and Gateway, Inc., and more recently Compaq, IBM and Apple;
distributors that sell directly to certain customers, such as MicroAge, Inc. and
Vanstar Corporation; various cost-plus aggregators, franchisers, and national
computer retailers, such as CompUSA, Inc., and companies with more extensive
Internet Web sites and commercial on-line networks. Additional competition may
arise if other new methods of distribution, such as broadband electronic
software distribution, emerge in the future.
The Company competes not only for customers, but also for favorable product
allocations and cooperative advertising support from product manufacturers.
Several of the Company's competitors are larger and have substantially greater
financial resources than the Company.
The Company believes that price, product selection and availability, and service
and support are the most important competitive factors in its industry.
8
INTELLECTUAL PROPERTY RIGHTS
The Company conducts its business under the marks PC Connection(R) and
MacConnection(R) and their related logos. Other Company trademarks and service
marks include Everything Overnight(R), One-Minute Mail Order(R), PC & Mac
Connection(R), Systems Connection(R), The Connection(R), Raccoon Character(R),
Service Connection(TM), Graphics Connection(TM), and Memory Connection(TM). The
Company intends to use and protect these and its other marks, as it deems
necessary. The Company believes its trademarks and service marks have
significant value and are an important factor in the marketing of its products.
The Company does not maintain a traditional research and development group, but
works closely with computer product manufacturers and other technology
developers to stay abreast of the latest developments in computer technology,
both with respect to the products it sells and the products it uses to conduct
its business.
EMPLOYEES
As of December 31, 1998, the Company employed 1,046 persons, of whom 449 were
engaged in sales related activities, 80 were engaged in providing customer
service and support, 331 were engaged in purchasing, marketing and distribution
related activities, 59 were engaged in the operation and development of
management information systems, and 127 were engaged in administrative and
accounting functions. The Company considers its employee relations to be good.
The Company's employees are not represented by a labor union, and it has
experienced no work stoppages since inception.
================================================================================
ITEM 2. PROPERTIES
================================================================================
In November 1997, the Company entered into a fifteen year lease for a new
corporate headquarters and telemarketing center located at Route 101A, 730
Milford Road, Merrimack, New Hampshire 03054-4631, with an affiliated entity,
related to the Company through common ownership. The Company occupied this
facility upon completion of construction in late November 1998, and the lease
payments commenced in December 1998. The Company also leases 140,000 square feet
in two facilities in Wilmington, Ohio, which houses its distribution and order
fulfillment operations. The Company also operates telemarketing centers in
Dover, Hudson, and Keene, New Hampshire. While the Company believes that its
existing distribution facilities in Wilmington, Ohio will be sufficient to
support the Company's anticipated needs through the next twelve months, it is
evaluating additional and/or alternative facilities for distribution to support
future growth.
================================================================================
ITEM 3. LEGAL PROCEEDINGS
================================================================================
The Company currently is not a party to any material legal proceedings, other
than ordinary routine litigation incidental to the business.
================================================================================
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
================================================================================
There were no matters submitted during the fourth quarter of 1998 to a vote of
securitity holders.
EXECUTIVE OFFICERS
The executive officers of the Company and their ages as of March 18, 1998 are as
follows:
NAME AGE POSITION
- ---- --- --------
Patricia Gallup 44 Chairman of the Board and Chief Executive Officer
David Hall 49 Vice Chairman of the Board
Wayne L. Wilson. 50 President and Chief Operating Officer
Robert F. Wilkins 37 Senior Vice President of Sales and Marketing
John L. Bomba, Jr. 45 Vice President of Information Services and Chief
Information Officer
Mark A. Gavin 37 Vice President of Finance and Chief Financial Officer
9
PATRICIA GALLUP is a co-founder of the company and has served as Chairman of the
Board and Chief Executive Officer of the Company since January 1998. From
September 1995 to January 1998, Ms. Gallup served as the Chairman of the Board,
President and Chief Executive Officer of the Company. From September 1994 to
September 1995, she served as Chairman of the Board and Chief Executive Officer
of the Company. From August 1990 to September 1994, Ms. Gallup served as the
Company's President and Chief Executive Officer.
DAVID HALL is a co-founder of the Company and has served as Vice Chairman of the
Board since November 1997. From June 1997 to November 1997, Mr. Hall served as
the Vice Chairman of the Board, Executive Vice President and Treasurer of the
Company. From February 1995 to June 1997, Mr. Hall served as the Company's Vice
Chairman of the Board and Executive Vice President. From March 1991 to February
1995, he served as the Executive Vice President of the Company.
WAYNE L. WILSON has served as President and Chief Operating Officer of the
Company since January 1998 and Chief Financial Officer from January 1998 to
March 1998. From January 1996 to January 1998, Mr. Wilson served as Senior Vice
President, Chief Operating Officer and Chief Financial Officer of the Company.
From August 1995 to January 1996, he served as Senior Vice President of Finance
and Chief Financial Officer of the Company. Prior to joining the Company, Mr.
Wilson was a partner in the accounting and consulting firm of Deloitte & Touche
LLP from June 1986 to August 1995.
ROBERT F. WILKINS has served as Senior Vice President of Merchandising and
Product Management of the Company since January 1998. From December 1995 to
January 1998. Mr. Wilkins served as Vice President of Merchandising and Product
Management of the Company. From September 1994 to December 1995 he was a
consultant to the Company and certain of its affiliates. From February 1990 to
September 1994, Mr. Wilkins served as President of Mac's Place.
JOHN L. BOMBA, JR. has served as Vice President of Information Services and
Chief Information Officer of the Company since May 1997. From May 1994 to April
1997, Mr. Bomba served as Director of Worldwide Information Systems for Micro
Warehouse, Inc. Prior to May 1994; he served as Director of Professional
Services for Innovative Information Systems, Inc.
MARK A. GAVIN has served as Vice President of Finance and Chief Financial
Officer of the Company since March 1998. Prior to joining PC Connection, Mr.
Gavin held the position of Executive Vice President and Chief Operating Officer
at CFX Corporation, a bank holding company in Keene, New Hampshire. Prior to
CFX, Mr. Gavin worked as a Manager for Ernst & Young, LLP.
PART II
================================================================================
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
================================================================================
Market Information
- ------------------
On March 6, 1998, the Company closed its initial public offering of 3,593,750
shares (including 468,750 shares issued upon the exercise of an underwriters'
overallotment option) of Common Stock (the "Offering") at an offering price of
$17.50 per share.
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "PCCC". The bid price information included herein is derived from the
Nasdaq Monthly Statistical Report. This report represents quotations by dealers,
may not reflect applicable markups, markdowns or commissions, and does not
necessarily represent actual transactions.
Common Stock
High Bid Low Bid
---------------------------
Calendar Year 1998
First Quarter $22 1/8 $18 5/8
Second Quarter 22 1/4 12
Third Quarter 25 3/4 9 3/4
Fourth Quarter 40 6
As of March 18, 1999, there were 15,624,856 shares outstanding of the Common
Stock of the Company held by approximately 70 stockholders of record.
10
================================================================================
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
================================================================================
The following selected financial and operating data should be read in
conjunction with the Company's 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, 1998 are derived from the
audited financial statements of the Company. The Company's financial statements
as of December 31, 1997 and 1998 and for each of the years in the three-year
period ended December 31, 1998 and the independent auditors' report thereon, are
included elsewhere herein:
Year Ended December 31,
-------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------
(dollars in thousands, except per share and selected operating data)
STATEMENT OF OPERATIONS DATA:
Net sales $ 732,370 $ 550,575 $ 333,322 $ 252,217 $ 196,659
Cost of sales 639,096 474,609 282,117 211,299 165,957
----------- ----------- ----------- ----------- -----------
Gross profit 93,274 75,966 51,205 40,918 30,702
Selling, general and administrative expenses 68,521 56,596 43,739 38,373 32,653
Additional stockholder/officer compensation/(1)/ 2,354 12,130 1,259 - -
----------- ----------- ----------- ----------- -----------
Income (loss) from operations 22,399 7,240 6,207 2,545 (1,951)
Interest expense (415) (1,355) (1,269) (1,296) (594)
Other, net 565 (42) 70 62 80
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 22,549 5,843 5,008 1,311 (2,465)
Income tax benefit (provision)/(2)/ (3,905) (639) (252) (38) 124
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 18,644 $ 5,204 $ 4,756 $ 1,273 $ (2,341)
=========== =========== =========== =========== ===========
PRO FORMA DATA/(3)/:
Net income $ 15,272 $ 10,890
=========== ===========
Basic net income per share $1.01 $.79
=========== ===========
Diluted net income per share $.98 $.76
=========== ===========
SELECTED OPERATING DATA:
Active customers/(4)/ 684,000 510,000 424,000 353,000 295,000
Catalogs distributed 42,150,000 33,800,000 18,600,000 16,800,000 16,900,000
Orders entered(5) 1,510,000 1,252,000 910,000 854,000 803,000
Average order size(5) $ 580 $ 524 $ 453 $ 346 $ 282
December 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
-----------------------------------------------------------------------
(dollars in thousands)
BALANCE SHEET DATA:
Working capital $ 53,768 $ 18,907 $ 14,622 $ 10,994 $ 2,770
Total assets 164,510 105,442 77,358 49,661 53,830
Short-term debt 123 29,568 13,057 4,933 6,106
Long-term debt (less current maturities):
Capital lease obligations 7,081 - - - -
Term loan - 3,250 4,250 5,000 -
Total stockholders' equity 69,676 24,120 18,043 13,057 11,687
(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) Elimination of stockholder/officer compensation in excess of aggregate
annual base salaries of $600 in effect during 1998 in accordance with
employment agreements; and
(ii) Computation of income tax expense assuming an effective tax rate of
approximately 39% (see Note 9 to the financial statements) and after
adjusting stockholder/officer compensation expense described in (i)
above.
(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.
11
================================================================================
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
================================================================================
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's 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, continued sales of Mac products, competitive risks, pricing
risks, Year 2000 compliance issues 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. In late 1996 the Company commenced selling products through
its 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 19.9% of net sales for the year ended December 31,
1998. Although net sales attributable to Mac products increased in the year
ended December 31, 1998, as compared to the comparable period in 1997, the
Company believes that such sales will continue to decrease as a percentage of
net sales and may decline in dollar volume in 1999 and future years.
All of the Company's product categories experienced strong growth in the year
ended December 31, 1998 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 $580 in the year ended December
31, 1998. 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 two 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.
The direct marketing of personal computers and related products is highly
competitive. In addition to other direct marketers and manufacturers who sell
direct, such as Dell Computer Corporation ("Dell") and Gateway, Inc.
("Gateway"), manufacturers of PCs sold by the Company, such as Compaq and IBM,
have also announced varying plans to sell PCs directly to end users. Separately,
both Compaq and IBM have announced plans to increase their
12
reliance on reseller arrangements with direct marketers such as the Company as
part of their own marketing programs designed to compete more effectively with
Dell and Gateway. The Company currently believes that direct sales by Compaq and
IBM will not have a significant adverse effect upon the Company's net sales.
Most product manufacturers provide the Company with 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.
In connection with the relocation of its headquarters facility beginning in
October 1998, the Company incurred certain one-time moving and other costs of
approximately $300,000, which were charged to operating costs. In connection
with the Offering of the Company's Common Stock that closed in March 1998, the
Company reported certain non-recurring, non-cash items in the year ended
December 31, 1998. See "Initial Public Offering" and "Pro Forma and Other
Adjustments" below.
INITIAL PUBLIC OFFERING
On March 6, 1998, the Company closed its Offering of 3,593,750 shares (including
468,750 shares issued upon the exercise of an underwriters' overallotment
option) of Common Stock at an offering price of $17.50 per share. Net proceeds
to the Company after deducting expenses of the Offering were approximately $57.3
million. See "Liquidity and Capital Resources."
PRO FORMA AND OTHER ADJUSTMENTS
The pro forma income statements presented below have been determined by applying
the following pro forma and other adjustments to the Company's historical income
statements containing periods prior to March 6, 1998:
Pro Forma Adjustments
- ---------------------
1. Elimination of stockholder/officer compensation in excess of aggregate
established 1998 annual base salaries ($600,000) for all periods prior to
March 6, 1998. The amounts eliminated generally represent Company-related S
Corporation tax obligations payable by the stockholder/officers for periods
prior to March 6, 1998.
2. Elimination of the historical income tax benefit/provision for all periods
prior to March 6, 1998 (including elimination of the $4.2 million income
tax benefit related to the establishment of additional deferred tax assets
for future tax deductions resulting from the termination of the Company's
Subchapter S Corporation status) and establishment of a provision for
federal and state income taxes that would have been payable by the Company
if taxed under Subchapter C of the Internal Revenue Code, assuming an
effective tax rate of approximately 39% after an adjustment for
stockholder/officer compensation described in Paragraph 1 above.
Other Adjustments
- -----------------
1. Elimination for the year ended December 31, 1998 of an $870,000 one-time
charge for stock option compensation expense relating to the acceleration
in the vesting period of certain of the Company's stock options from seven
years to four years in connection with the Offering.
13
PRO FORMA INCOME STATEMENTS, AS ADJUSTED
YEAR ENDED DECEMBER 31,
----------------------------------------
% OF % OF
(Amounts in thousands, except per share data) 1998 NET SALES 1997 NET SALES
----------------------------------------
Net sales $732,370 100.00% $550,575 100.00%
Cost of sales 639,096 87.26 474,609 86.20
-------- ------ -------- ------
GROSS PROFIT 93,274 12.74 75,966 13.80
Selling, general and administrative expenses 67,651 9.24 56,596 10.28
Additional stockholder/officer compensation - - 120 .02
-------- ------ -------- ------
Income from operations 25,623 3.50 19,250 3.50
Interest expense (415) (.06) (1,355) (.25)
Other, net 565 .08 (42) (.01)
-------- ------ -------- ------
Income before income taxes 25,773 3.52 17,853 3.24
Income taxes (9,971) (1.36) (6,963) (1.26)
-------- ------ -------- ------
PRO FORMA NET INCOME, AS ADJUSTED $ 15,802 2.16% $ 10,890 1.98%
======== ====== ======== ======
Weighted average shares outstanding:
Basic 15,165 13,861
======== ========
Diluted 15,669 14,244
======== ========
Pro forma earnings per share, as adjusted:
Basic $ 1.05 $ .79
======== ========
Diluted $ 1.02 $ .76
======== ========
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,
------------------------
1998 1997 1996
------------------------
Net sales (in millions) $732.4 $550.6 $333.3
====== ====== ======
Net sales 100.0% 100.0% 100.0%
Gross profit 12.7 13.8 15.4
Selling, general and administrative expenses 9.4 10.3 13.1
Additional stockholder/officer compensation 0.3 2.2 0.4
Income from operations 3.1 1.3 1.9
Interest expense (0.0) (0.2) (0.4)
Income before income taxes 3.1 1.0 1.5
Income taxes (0.5) (0.1) (0.1)
Net income 2.6 0.9 1.4
Pro forma net income 2.1 2.0
The following table sets forth for the periods indicated the Company's
percentage of net sales (in dollars) of computer systems/memory, peripherals,
software and networking and communications products.
YEAR ENDED DECEMBER 31,
----------------------
1998 1997 1996
----------------------
PRODUCT CATEGORIES
- ------------------
Computer Systems/Memory 43.7% 42.2% 34.8%
Peripherals 34.5 34.3 38.0
Software 14.0 15.8 17.6
Networking and Communications 7.8 7.7 9.6
----- ----- -----
Total 100.0% 100.0% 100.0%
===== ===== =====
14
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.
Selling, general and administrative expenses, excluding the one-time charge for
stock option compensation expense, increased by $11.1 million, or 19.5%, to
$67.7 million for the year ended December 31, 1998 from $56.6 million for the
comparable period in 1997, but decreased as a percentage of sales from 10.3% in
1997 to 9.2% in 1998.
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 each of 1997 and 1996)
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. Selling, general and administrative
expenses on a pro forma basis were $56.7 million, or 10.3% of net sales, for
1997, as adjusted to give effect to $600,000 of aggregate base salaries payable
to the Company's two stockholder/officers. 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 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. Income from operations,
excluding additional stockholder/officer compensation, for the year ended
December 31, 1998 was $24.8 million, an increase of $5.4 million, or 27.8%, over
the prior year income of $19.4 million. Income from operations as a percentage
of net sales, excluding additional stockholder/officer compensation, decreased
from 3.5% in 1997 to 3.4% in 1998.
Income from operations, excluding both the one-time charge for stock option
compensation expense in 1998 ($870,000) and the additional stockholder/officer
compensation in excess of their aggregate annual base salaries of $600,000 ($2.4
million and $12.0 million for the year ended December 31, 1998 and 1997,
respectively), increased by $6.3 million, or 33.1%, to $25.6 million for the
year ended December 31, 1998 from $19.3 million for the comparable period in
1997. Such income from operations as a percentage of net sales was 3.5% for 1998
and 1997.
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.
15
Pro forma net income for 1998 and 1997 is determined by (i) eliminating
stockholder/officer compensation in excess of the aggregate base salaries
($600,000) described above under "selling, general and administrative expenses"
and (ii) adding a provision for federal income taxes that would have been
payable by the Company if taxed under Subchapter C of the Internal Revenue Code.
Net income on a pro forma basis as described above would have been $15.3 million
for 1998, compared to $10.9 million for 1997. The difference in pro forma net
income compared to historical net income represents the elimination of $2.4
million and $12.0 million in stockholder/officer compensation in 1998 and 1997,
respectively, offset by higher provisions for federal income taxes of $5.7
million and $6.3 million, respectively.
Excluding a one-time charge for the acceleration of certain stock option
compensation expense (described above), the Company would have reported pro
forma net income of $15.8 million, or $1.02 per share, for the year ended
December 31, 1998, compared to pro forma net income of $10.9 million, or $.76
per share, for the comparable period in 1997, an increase of $.26 per share, or
34%.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net Sales increased $217.3 million, or 65.2%, to $550.6 million in 1997 from
$333.3 million in 1996. Growth in net sales, which included a 15.7% increase in
average order size, was primarily attributable to: (i) improvements in
merchandising and product mix, especially a greater emphasis on 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) improved inbound sales conversion ratios.
System/memory sales increased to 42.2% of net sales in 1997 from 34.8% in 1996.
Outbound sales increased by $130.5 million, or 103.1%, to $257.2 million in 1997
from $126.7 million in 1996. The number of catalogs mailed increased by 81.7%,
from 18.6 million catalogs in 1996 to 33.8 million catalogs in 1997.
Gross Profit increased by $24.8 million, or 48.4%, to $76.0 million in 1997 from
$51.2 million in 1996. The increase in gross profit dollars was primarily
attributable to the increase in net sales described above. Gross profit margin
decreased from 15.4% in 1996 to 13.8% in 1997 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
generated higher gross profit dollars per order, enabling it to leverage its
operating expenses.
Selling, general and administrative expenses increased by $12.8 million, or
29.4%, to $56.6 million in 1997 from $43.7 million in 1996, but decreased as a
percentage of sales to 10.3% in 1997 from 13.1% in 1996. The increase in
expenses was primarily 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 improved expense control and the leveraging
of selling, general and administrative expenses over a larger sales base.
Selling, general and administrative expenses on a pro forma basis, after
elimination of stockholder/officer compensation in excess of $600,000 were $56.7
million (or 10.3% of net sales) for 1997, compared to $43.9 million for 1996.
Additional stockholder/officer compensation increased by $10.8 million, or
863.5%, to $12.1 million in 1997 from $1.3 million in 1996. This increase is
attributable to increases in net income.
Income from operations increased by $1.0 million, or 16.6%, to $7.2 million in
1997 from $6.2 million in 1996. Income from operations as a percentage of net
sales decreased from 1.9% to 1.3% for the reasons discussed above. Income from
operations, excluding additional stockholder/officer compensation, for the years
ended December 31, 1997 and 1996 was $19.4 million and $7.5 million,
respectively, an increase of $11.9 million, or 159.4%. Income from operations as
a percentage of net sales, excluding additional stockholder/officer
compensation, increased from 2.2% to 3.5% for the reasons discussed above.
Interest expense in 1997 increased by $86,000, or 6.8%, to $1.4 million in 1997
from $1.3 million in 1996, primarily due to higher average outstanding
borrowings under the Company's line of credit.
Net income increased $448,000, or 9.4%, to $5.2 million in 1997 from $4.8
million in 1996, principally as a result of the increase in income from
operations.
Pro forma net income would have been $10.9 million for 1997, based on the pro
forma adjustments referred to above. The difference in pro forma net income
compared to historical net income represents the elimination of $12.0 million in
stockholder/officer compensation offset by a $6.3 million higher provision for
federal income taxes.
16
SELECTED QUARTERLY FINANCIAL RESULTS
The following table sets forth certain unaudited quarterly data of the Company
for each of the quarters since January 1, 1997. 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,
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
======== ======== ========
Pro forma data:
Historical income before income taxes $ 2,617
Pro forma adjustment - stockholder/officer compen-
sation in excess of the aggregate base salaries 2,354
--------
Pro forma income before taxes 4,971
Pro forma income taxes 1,938
--------
Pro forma net income/(2)/ $ 3,033
========
Pro forma weighted average shares outstanding:
Basic 14,236
========
Diluted 14,835
========
Pro forma earnings per share:
Basic $ .21
========
Diluted $ .20
========
17
QUARTERS ENDED
--------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997
--------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales $122,823 $121,500 $139,137 $167,115
Cost of sales 105,444 104,723 119,841 144,601
-------- -------- -------- --------
Gross profit 17,379 16,777 19,296 22,514
Selling, general and administrative expenses 13,637 12,791 14,537 15,631
Additional stockholder/officer compensation 2,450 2,980 3,200 3,500
-------- -------- -------- --------
Income from operations 1,292 1,006 1,559 3,383
Interest expense (367) (299) (267) (422)
Other, net 5 (11) (37) 1
-------- -------- -------- --------
Income before income taxes 930 696 1,255 2,962
Income tax provision/(1)/ (130) (134) (165) (210)
-------- -------- -------- --------
Net income $ 800 $ 562 $ 1,090 $ 2,752
======== ======== ======== ========
Pro forma data:
Historical income before income taxes $ 930 $ 696 $ 1,255 $ 2,962
Pro forma adjustment - stockholder/officer
compensation in excess of the aggregate
base salaries 2,420 2,950 3,170 3,470
-------- -------- -------- --------
Pro forma income before taxes 3,350 3,646 4,425 6,432
Pro forma income taxes 1,307 1,422 1,726 2,508
-------- -------- -------- --------
Pro forma net income/(2)/ $ 2,043 $ 2,224 $ 2,699 $ 3,924
======== ======== ======== ========
Pro forma weighted average shares outstanding:
Basic 13,861 13,861 13,861 13,861
======== ======== ======== ========
Diluted 14,149 14,124 14,259 14,393
======== ======== ======== ========
Pro forma earnings per share:
Basic $ .15 $ .16 $ .20 $ .28
======== ======== ======== ========
Diluted $ .14 $ .16 $ .19 $ .27
======== ======== ======== ========
/(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) eliminating stockholder/officer
compensation in excess of the aggregate base salaries ($600,000) per year
and (ii) 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.
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
Offering and available credit under its bank line of credit, will be sufficient
to finance its working capital and capital expenditure requirements at least
through 1999. The Company's ability to continue funding its planned growth is
dependent upon its ability to generate sufficient cash flow from operations or
to obtain additional funds through equity or debt financing, or from other
sources of financing, as may be required.
At December 31, 1998, the Company had cash and cash equivalents of $11.9 million
and working capital of $53.8 million. At December 31, 1997, the Company had
working capital of $18.9 million.
Net cash provided by operating activities was $29.4 million in the year ended
December 1998, compared to $10.4 million and $4.5 million used in the years
ended December 31, 1997, and 1996, 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. Additionally, receivables from vendors increased due to the increased
activity in vendor rebate and other programs.
18
Capital expenditures were $9.9 million and $4.5 million in the years ended
December 31, 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 $10.0 million for the year ending
December 31, 1999.
As of December 31, 1998, the Company had a credit agreement with a bank
providing for short-term borrowings equal to the lesser of $45.0 million or an
amount determined by a formula based on accounts receivable and inventory
balances. Borrowings under this agreement are collateralized by the Company's
accounts receivable and inventories (other than inventories pledged to secure
trade credit arrangements) and bear interest at the bank's prime rate (7.75% at
December 31, 1998) or LIBOR plus 2.0% at the Company's option. No amounts were
outstanding under this agreement as of December 31, 1998. The credit agreement
includes various customary financial and operating covenants, including
restrictions on the payment of dividends, except for dividends to stockholders
in respect of income taxes, none of which the Company believes significantly
restricts the Company's operations.
At December 31, 1998, the Company had $77.6 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 $21.8 million payable to two financial
institutions under security agreements to facilitate the purchase of inventory.
YEAR 2000 COMPLIANT INFORMATION SYSTEMS
The change in date from 1999 to 2000 poses potential problems for many computer
and electro-mechanical systems around the world. Some of the Company's systems
could be affected by this problem which could have a material adverse effect on
the Company's business, financial condition and results of operations.
In order to minimize any potential disruption to the Company's business, the
Company has an active, on-going program to evaluate its systems and take
corrective action prior to the millennium change. A full-time senior manager is
responsible for managing the Year 2000 Project, which is comprised of five
phases: awareness, assessment, renovation, validation and implementation. For
each system that is determined to be non-compliant, the Company is taking one of
the following three courses of action to achieve date compliance: (i) renovate
(convert) the current system; (ii) replace the current system with a new date
compliant system; or (iii) retire the current system because it no longer
serves a valid business need.
The Company recently replaced its order management and fulfillment software with
new software and converted its principal computer equipment to new IBM AS400
platform systems, both of which are better suited to the Company's expected
scale of operations and are designed to be Year 2000 compliant. The Company is
investigating the extent to which its other systems may be affected and
communicating to all of its system vendors concerning timely and completed
remedies for those systems requiring modification. The Company currently
believes it will be able to modify or replace any affected systems in time to
minimize any detrimental effect on operations.
The Company is also communicating with all third parties on which it relies to
assess their progress in evaluating their systems and implementing appropriate
corrective measures. Furthermore, the Company is actively encouraging its
customers to undertake their own Year 2000 compliance projects in order to
ensure the continued viability of the Company's commercial business pursuits.
The Company has been taking, and will continue to pursue, all reasonably
necessary steps to protect its operations, assets and the interests of its
customers, shareholders, employees and community partners.
Utilizing both internal and external resources to identify and assess needed
Year 2000 remediation, the Company currently anticipates that its Year 2000
awareness, assessment, renovation and validation efforts, which began in 1996,
will be completed by June 30, 1999, and that such efforts will be completed
prior to any currently anticipated impact on its computer equipment and
software. The Company estimates that as of December 31, 1998 it had completed
approximately 80% of the initiatives that it believes will be necessary to fully
address potential Year 2000 issues relating to its computer equipment and
software. The majority of the projects comprising the remaining 20% of the
initiatives are in process and expected to be substantially completed by June
30, 1999.
19
TIME PERCENT
FRAME COMPLETED
----- ---------
Status of overall Year 2000 Project:
Awareness 10/97 - 06/98 100%
Assessment 10/97 - 12/98 100%
Renovation 04/98 - 09/99 75%
Validation 05/98 - 11/99 65%
Implementation 05/98 - 12/99 75%
Summary of significant Year 2000 projects completed:
Conversion to new IBM AS400 10/96 - 09/98 100%
Conversion to new order management and fulfillment software 10/96 - 09/98 100%
The primary objectives of the Year 2000 Project relating to the Company's
internal systems were met when the Company implemented its new order management
and fulfillment software and upgraded its IBM AS400 data processing platform.
The majority of the costs (approximately $5.5 million) of the new software and
hardware were capitalized during the period October 1, 1997 to September 30,
1998. The Company believes that the costs of its Year 2000 awareness,
assessment, renovation, validation and implementation for all other computer
equipment and software, as well as currently anticipated costs to be incurred by
the Company with respect to Year 2000 issues of third parties, will not exceed
$500,000, which will be funded from operating cash flow. These costs will be
expensed as incurred.
The Company presently believes that the Year 2000 issue will not pose
significant operational problems for the Company. However, for all Year 2000
issues that are not properly identified, or assessments, renovation, validation
and implementation are not effected timely with respect to Year 2000 problems,
there can be no assurance that the Year 2000 issues of other entities will not
have a material adverse impact on the Company's systems or results of
operations.
The Company is presently undertaking, a comprehensive analysis of the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with worst
case scenarios, and such scenarios have not yet been clearly identified. The
Company currently plans to complete such analysis and contingency planning
before December 31, 1999.
The costs of the Company's Year 2000 awareness, assessment, renovation,
validation and implementation efforts and the dates on which the Company
believes it will complete such efforts are based upon management's best
estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
remediation plans, and other factors. There can be no assurance that these
estimates will prove to be accurate and actual results could differ materially
from those currently anticipated. Specific factors that could cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in Year 2000 issues, the ability to assess, renovate and
implement all relevant computer codes and embedded technology and similar
uncertainties. In addition, variability of definitions of "Year 2000 Compliance"
and the myriad of different products and services and combinations thereof, sold
by the Company may lead to claims whose impact on the Company is not currently
estimable. No assurance can be given that the aggregate cost of defending and
resolving such claims, if any, will not materially adversely affect the
Company's results of operations. Although some of the Company's agreements with
manufacturers and others from whom it purchases products for resale contain
provisions requiring such parties to indemnify the Company under some
circumstances, there can be no assurance that such indemnification arrangements
will cover all of the Company's liabilities and costs related to claims by third
parties related to the Year 2000 issue.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", effective for fiscal years beginning after
June 15, 1999. The new standard requires that all companies record derivatives
on the balance sheet as assets or liabilities, measured at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. Management is currently assessing the impact of SFAS No.
133 on the financial statements of the Company. The Company will adopt this
accounting standard on January 1, 2000, as required.
INFLATION
The Company has historically offset any inflation in operating costs by a
combination of increased productivity and price increases, where appropriate.
The Company does not expect inflation to have a significant impact on its
business in the future.
20
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
The Company's future results and financial condition are dependent on the
Company's ability to continue to successfully market, sell, and distribute
computers, hardware and software. Inherent in this process are a number of
factors that the Company must successfully manage in order to achieve favorable
operating results and financial condition. Potential risks and uncertainties
that could affect the Company's future operating results and financial condition
include, without limitation, the factors discussed below:
No Assurance of Future Growth
- ------------------------------
Net sales have grown from $196.7 million for the year ended December 31, 1994 to
$732.4 million for the year ended December 31, 1998. This growth has placed
increasing demands on the Company's management resources and facilities. The
Company's business strategy is to pursue additional growth and expand its
customer base, which is likely to result in additional demands on the Company's
resources. The Company's future success will depend in part on the ability of
the Company to manage any future growth effectively. There can be no assurance
that the Company will realize future growth in net sales or will not experience
decreases in net sales.
Risks Related to Transition or Expansion of Facilities
- -------------------------------------------------------
Additional and/or alternative facilities for distribution and sales may be
required to support significant future growth in the Company's net sales, if
realized. There can be no assurance that suitable facilities will be available,
and in the absence of such facilities, future growth could be impaired.
Dependence on Management Information Systems
- ---------------------------------------------
The Company's success is dependent on the accuracy, reliability and proper use
of its management information systems, including its telephone system, and the
information generated by its management information systems. The Company does
not currently have redundant systems for all functions performed by its
management information systems or a redundant or back-up telephone system. Any
interruption in these systems or in telephone service could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
Rapid Technological Change and Exposure to Inventory Obsolescence
- ------------------------------------------------------------------
The market for personal computer products is characterized by rapid
technological change and the frequent introduction of new products and product
enhancements. The Company's success depends in part on its ability to identify
and market products that meet the needs of the marketplace. In order to satisfy
customer demand and to obtain favorable purchasing discounts, the Company may
carry increased inventory levels of certain products in the future, which will
subject it to increased risk of inventory obsolescence. In the implementation of
its business strategy, the Company intends, among other things, to place larger
than typical inventory stocking orders, increase its participation in first-to-
market purchase opportunities, and may in the future participate in end-of-life-
cycle purchase opportunities and market products on a private-label basis, all
of which will further increase the risk of inventory obsolescence. Special
purchase products are sometimes acquired without return privileges and there can
be no assurance that the Company will be able to avoid losses related to
obsolete inventory. In addition, some manufacturers provide the Company with co-
op advertising support in the form of products, for which there may be no return
privileges. Finally, certain build-to-order programs currently being implemented
by some computer systems manufacturers will likely include reductions in the
levels of price protection and product returns made available by such
manufacturers. See "Business--Products and Merchandising."
Availability and Allocation of Goods
- -------------------------------------
The Company acquires products for resale from manufacturers as well as from
distributors. Purchases of products from the five vendors supplying the greatest
amount of goods to the Company constituted 44.5% and 46.5% of the Company's
total product purchases in the years ended December 31, 1998 and 1997,
respectively. Among these five vendors, purchases from Ingram Micro, Inc.
("Ingram Micro") represented 20.3% and 28.0% of the Company's total product
purchases in the years ended December 31, 1998 and 1997, respectively. No other
vendor supplied more than 10% of the Company's total product purchases in the
year ended December 31, 1998. The loss of Ingram Micro could cause a short-term
disruption in the availability of products and could have a material adverse
effect on the Company's financial position, results of operations and cash
flows.
21
Substantially all of the Company's contracts and arrangements with its vendors
that supply significant quantities of products are terminable by such vendors or
the Company without notice or upon short notice. Most of the Company's product
vendors provide the Company with trade credit, of which the net amount
outstanding at December 31, 1998 was $72.2 million. Termination, interruption or
contraction of the Company's relationships with its vendors, including a
reduction in the level of trade credit provided to the Company, could have a
material adverse effect on the Company's financial position, results of
operations and cash flows. See "Business--Purchasing and Vendor Relations."
Certain product manufacturers either do not permit the Company to sell the full
line of their products or limit the number of product units available to direct
marketers such as the Company. An element of the Company's business strategy is
to increase its participation in first-to-market purchase opportunities. In the
past, availability of certain desired products, especially in the direct
marketing channel, has been constrained. The inability to source first-to-market
purchase or similar opportunities, or the reemergence of significant
availability constraints, could have a material adverse effect on the Company's
financial position, results of operations and cash flows.
Reliance on Vendor Support and Relationships
- ---------------------------------------------
Some product manufacturers and distributors provide the Company with substantial
incentives in the form of payment discounts, supplier reimbursements, price
protection and rebates. No assurance can be given that the Company will continue
to receive such incentives in the future or that it will be able to collect
outstanding amounts relating to any future incentives in a timely manner or at
all.
Most product manufacturers provide the Company with co-op advertising support in
exchange for product coverage in the Company's catalogs. This support
significantly defrays the expense of catalog production. The level of co-op
advertising support available to the Company from certain manufacturers has
declined. The level of support from some manufacturers may further decline in
the future. Such a decline could increase the Company's selling, general and
administrative expenses as a percentage of sales and have a material adverse
effect on the Company's financial position, results of operations and cash
flows. See "Business--Purchasing and Vendor Relations."
Competitive Risks
- ------------------
The Company competes with national and international direct marketers; product
manufacturers that sell directly to end users; specialty personal computer
retailers; personal computer and general merchandise superstores; consumer
electronic and office supply stores; and shopping services on television, the
Internet and commercial on-line networks. The Company competes not only for
customers, but also for co-op advertising support from personal computer product
manufacturers. Some of the Company's competitors are larger and have
substantially greater financial resources, superior operating results, and
larger catalog circulations and customer bases than the Company. In addition,
several direct marketers have recently been acquired by larger competitors. This
industry consolidation could result in short-term price-cutting in certain
markets. There can be no assurance that the Company will be able to compete
effectively with existing competitors or any new competitors that may enter the
market, or that the Company's financial position, results of operations and cash
flows will not be adversely affected by intensified competition. See "Business--
Competition."
Pricing Risks
- --------------
The personal computer industry has experienced intense price competition. The
Company believes that price competition may increase in the future and that such
competition could result in a reduction of the Company's profit margins. Also,
the Company has recently increased its sales of personal computer hardware
products that generally produce lower profit margins than those associated with
software products. Significant margin decreases could have a material adverse
effect on the Company's financial position, results of operations and cash
flows.
Economic Risks
- ---------------
The market for personal computers and related products has grown rapidly in
recent years. Recent statements by industry observers have indicated that there
may be a slowdown in the growth rate of the personal computing industry. If the
growth of this market or the direct marketing channel were to cease or decrease,
the Company's financial position, results of operations and cash flows would be
materially adversely affected. Demand for many of the products carried by the
Company may be subject to economic cycles. The Company's business and growth
could be affected by the spending patterns of existing or prospective customers,
a recession or prolonged economic slowdown, the cyclical nature of capital
expenditures of businesses, continued competition and pricing pressures and
other trends in the general economy, any one of which could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
22
Dependence on Third Party Shippers
- -----------------------------------
The Company ships approximately 75% of its products to customers by Airborne
Freight Corporation D/B/A "Airborne Express" ("Airborne Express"), with the
remainder being shipped by United Parcel Service of America, Inc. and other
overnight delivery and surface services. Strikes or other service interruptions
by such shippers could adversely affect the Company's ability to market or
deliver product on a timely basis and have a material adverse effect on the
Company's financial position, results of operations and cash flows. See
"Business--Distribution."
Potential Increases in Shipping, Paper and Postage Costs
- ---------------------------------------------------------
Shipping costs are a significant expense in the operation of the Company's
business. The Company has a long-term contract with Airborne Express for
shipment of its products under which the Company believes it has negotiated
favorable shipping rates. The Company generally invoices customers for shipping
and handling charges. There can be no assurance that the full cost, including
any future increases in the cost, of commercial delivery services can be passed
on to the Company's customers, which could have a material adverse effect on the
Company's financial position, results of operations and cash flows. In addition,
the current shipping rates under the Airborne Express contract are subject to
renegotiation in 1999, and there can be no assurance that such renegotiated
rates will continue to be as favorable to the Company, which could have a
material adverse effect on the Company's financial position, results of
operations and cash flows. See "Business--Distribution" and "Business--Marketing
and Sales."
The Company also incurs substantial paper and postage costs related to its
marketing activities, including its catalog production and mailings. Any
increases in postal or paper costs could have a material adverse effect on the
Company's financial position, results of operations and cash flows.
No Assurance of Future Profitability; Variability of Quarterly Results
- -----------------------------------------------------------------------
The Company has experienced significant fluctuations in its operating results,
and these fluctuations may continue in the future. The Company incurred net
losses in the year ended December 31, 1994. The Company's results of operations
are significantly affected by many factors, including seasonal and other
fluctuations in demand for personal computer products and in profit margins on
products sold, catalog timing and circulation, product availability, and timing
of releases of new and upgraded products. Many of these factors are outside the
control of the Company. The Company's operating results are heavily dependent
upon its ability to predict sales levels, monitor and control associated
expenses, and carefully manage all aspects of its operations, including product
selection and pricing, purchasing and payables practices, inventory management,
and catalog funding, production and circulation. If revenues do not meet
expectations in any given quarter, or if the Company experiences difficulty in
monitoring or controlling associated expenses, the Company's financial position,
results of operations and cash flows may be materially adversely affected. There
can be no assurance that the Company will be profitable on a quarterly or annual
basis. It is possible that in some future quarter the expectations of public
ma