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EX-31.1 - EX-31.1 - PCM, INC.a10-12834_1ex31d1.htm
EX-31.2 - EX-31.2 - PCM, INC.a10-12834_1ex31d2.htm
EX-32.1 - EX-32.1 - PCM, INC.a10-12834_1ex32d1.htm
EX-10.1 - EX-10.1 - PCM, INC.a10-12834_1ex10d1.htm
EX-32.2 - EX-32.2 - PCM, INC.a10-12834_1ex32d2.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

OR

 

£         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                  

 

Commission File Number: 0-25790

 

PC MALL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4518700

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

2555 West 190th Street, Suite 201

Torrance, CA 90504

(Address of principal executive offices)

 

(310) 354-5600

(Registrant’s telephone number, including area code)

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of August 4, 2010, the registrant had 12,220,381 shares of common stock outstanding.

 

 

 



 

PC MALL, INC.

 

TABLE OF CONTENTS

 

 

Page

PART I - FINANCIAL INFORMATION (unaudited)

 

 

 

Item 1. Financial Statements

 

 

 

Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

2

 

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and June 30, 2009

3

 

 

Consolidated Statement of Stockholders’ Equity for the Six Months Ended June 30, 2010

4

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and June 30, 2009

5

 

 

Notes to the Consolidated Financial Statements

6

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

11

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

26

 

 

Item 4. Controls and Procedures

27

 

 

PART II - OTHER INFORMATION (unaudited)

 

 

 

Item 1. Legal Proceedings

27

 

 

Item 1A. Risk Factors

27

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

Item 6. Exhibits

43

 

 

Signature

44

 

1



 

PC MALL, INC.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except per share amounts and share data)

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

12,988

 

$

9,215

 

Accounts receivable, net of allowances of $2,389 and $2,740

 

170,007

 

161,468

 

Inventories, net

 

52,887

 

68,564

 

Prepaid expenses and other current assets

 

13,123

 

9,290

 

Deferred income taxes

 

3,386

 

3,297

 

Total current assets

 

252,391

 

251,834

 

Property and equipment, net

 

21,689

 

17,091

 

Deferred income taxes

 

1,010

 

1,538

 

Goodwill

 

25,510

 

19,291

 

Intangible assets, net

 

12,756

 

10,354

 

Other assets

 

951

 

1,068

 

Total assets

 

$

314,307

 

$

301,176

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

103,250

 

$

108,773

 

Accrued expenses and other current liabilities

 

25,747

 

25,148

 

Deferred revenue

 

14,428

 

9,714

 

Line of credit

 

64,842

 

53,127

 

Note payable — current

 

1,148

 

1,038

 

Total current liabilities

 

209,415

 

197,800

 

Note payable and other long-term liabilities

 

4,990

 

5,621

 

Total liabilities

 

214,405

 

203,421

 

Commitments and contingencies (Note 10)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding

 

 

 

Common stock, $0.001 par value; 30,000,000 shares authorized; 14,079,365 and 14,031,740 shares issued; and 12,226,006 and 12,290,652 shares outstanding, respectively

 

14

 

14

 

Additional paid-in capital

 

103,629

 

102,361

 

Treasury stock, at cost: 1,853,359 and 1,741,088 shares

 

(6,808

)

(6,254

)

Accumulated other comprehensive income

 

2,008

 

2,111

 

Accumulated earnings (deficit)

 

1,059

 

(477

)

Total stockholders’ equity

 

99,902

 

97,755

 

Total liabilities and stockholders’ equity

 

$

314,307

 

$

301,176

 

 

See Notes to the Consolidated Financial Statements.

 

2



 

PC MALL, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

$

316,983

 

$

261,412

 

$

606,837

 

$

520,712

 

Cost of goods sold

 

276,428

 

225,575

 

528,253

 

447,380

 

Gross profit

 

40,555

 

35,837

 

78,584

 

73,332

 

Selling, general and administrative expenses

 

37,708

 

33,880

 

74,961

 

69,315

 

Operating profit

 

2,847

 

1,957

 

3,623

 

4,017

 

Interest expense, net

 

507

 

324

 

989

 

688

 

Income before income taxes

 

2,340

 

1,633

 

2,634

 

3,329

 

Income tax expense

 

977

 

818

 

1,098

 

1,503

 

Net income

 

$

1,363

 

$

815

 

$

1,536

 

$

1,826

 

Basic and Diluted Earnings Per Common Share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

$

0.07

 

$

0.13

 

$

0.15

 

Diluted

 

0.11

 

0.06

 

0.12

 

0.14

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

12,270

 

12,296

 

12,280

 

12,356

 

Diluted

 

12,565

 

12,674

 

12,596

 

12,620

 

 

See Notes to the Consolidated Financial Statements.

 

3



 

PC MALL, INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(unaudited, in thousands)

 

 

 

 

 

 

 

Additional

 

 

 

Accumulated
Other

 

Accumulated

 

 

 

 

 

Common Stock

 

Paid-in-

 

Treasury

 

Comprehensive

 

Earnings

 

 

 

 

 

Outstanding

 

Amount

 

Capital

 

Stock

 

Income

 

(Deficit)

 

Total

 

Balance at December 31, 2009

 

12,291

 

$

14

 

$

102,361

 

$

(6,254

)

$

2,111

 

$

(477

)

$

97,755

 

Stock option exercises and restricted stock awards, including related income tax benefit

 

47

 

 

101

 

 

 

 

 

101

 

Stock-based compensation expense

 

 

 

1,167

 

 

 

 

1,167

 

Purchase of common stock under a repurchase program

 

(112

)

 

 

 

 

(554

)

 

 

 

 

(554

)

Subtotal

 

 

 

 

 

 

 

98,469

 

Net income

 

 

 

 

 

 

1,536

 

1,536

 

Translation adjustments

 

 

 

 

 

(103

)

 

(103

)

Comprehensive income

 

 

 

 

 

 

 

1,433

 

Balance at June 30, 2010

 

12,226

 

$

14

 

$

103,629

 

$

(6,808

)

$

2,008

 

$

1,059

 

$

99,902

 

 

See Notes to the Consolidated Financial Statements.

 

4



 

PC MALL, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

Cash Flows From Operating Activities

 

 

 

 

 

Net income

 

$

1,536

 

$

1,826

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

3,731

 

2,622

 

Provision for deferred income taxes

 

421

 

570

 

Net tax benefit (expense) related to stock option exercises

 

43

 

(298

)

Excess tax benefit related to stock option exercises

 

(16

)

(278

)

Non-cash stock-based compensation

 

1,167

 

822

 

Gain on sale of fixed assets

 

(11

)

 

Change in operating assets and liabilities, net of assets and liabilities acquired:

 

 

 

 

 

Accounts receivable

 

(7,579

)

16,666

 

Inventories

 

15,677

 

20,202

 

Prepaid expenses and other current assets

 

(3,833

)

(80

)

Other assets

 

115

 

164

 

Accounts payable

 

(3,221

)

(11,241

)

Accrued expenses and other current liabilities

 

(2,997

)

(8,015

)

Deferred revenue

 

4,130

 

(3,464

)

Total adjustments

 

7,627

 

17,670

 

Net cash provided by operating activities

 

9,163

 

19,496

 

Cash Flows From Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(4,425

)

(3,135

)

Acquisition of NSPI, net of cash acquired

 

(8,788

)

 

Net cash used in investing activities

 

(13,213

)

(3,135

)

Cash Flows From Financing Activities

 

 

 

 

 

Repayments under notes payable

 

(550

)

(511

)

Net borrowings (payments) under line of credit

 

11,715

 

(14,968

)

Change in book overdraft

 

(2,446

)

(2,945

)

Payments of obligations under capital lease

 

(313

)

(60

)

Proceeds from stock issued under stock option plans

 

58

 

439

 

Excess tax benefit related to stock option exercises

 

16

 

278

 

Common shares repurchased and held in treasury

 

(554

)

(1,647

)

Net cash provided by (used in) financing activities

 

7,926

 

(19,414

)

Effect of foreign currency on cash flow

 

(103

)

283

 

Net change in cash and cash equivalents

 

3,773

 

(2,770

)

Cash and cash equivalents at beginning of the period

 

9,215

 

6,748

 

Cash and cash equivalents at end of the period

 

$

12,988

 

$

3,978

 

Supplemental Cash Flow Information

 

 

 

 

 

Interest paid

 

$

908

 

$

776

 

Income taxes paid

 

386

 

2,142

 

Supplemental Non-Cash Investing and Financing Activities

 

 

 

 

 

Purchase of infrastructure system

 

$

 

$

360

 

NSPI acquisition related:

 

 

 

 

 

Fair value of assets acquired, net of cash acquired

 

$

13,472

 

$

 

Net cash paid

 

(8,788

)

 

Liabilities assumed

 

$

4,684

 

$

 

 

See Notes to the Consolidated Financial Statements.

 

5



 

PC MALL, INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Basis of Presentation

 

PC Mall, Inc., together with its wholly-owned subsidiaries (collectively referred to as “PC Mall,” “we” or “us”), founded in 1987, is a value added direct marketer of technology products, services and solutions to businesses, government and educational institutions and individual consumers. We offer our products, services and solutions through dedicated account executives, field service teams, various direct marketing techniques and three retail stores. We also utilize distinctive full-color catalogs under the PC Mall, MacMall, PC Mall Gov and SARCOM brands and our websites pcmall.com, macmall.com, pcmallgov.com, gmri.com, sarcom.com, abreon.com, nspi.com and onsale.com and other promotional materials.

 

We have prepared the unaudited consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations for interim financial reporting. In the opinion of management, all adjustments, consisting only of normal recurring items which are necessary for a fair presentation, have been included. The results for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 16, 2010, as amended and filed on April 30, 2010, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 filed with the SEC on May 10, 2010, and all of our other periodic filings, including Current Reports on Form 8-K, filed with the SEC after the end of our 2009 fiscal year and through the date of this report.

 

2. Summary of New Accounting Standards

 

In October 2009, the FASB issued ASU 2009-14, “Certain Arrangements That Contain Software Elements (Topic 985) — a consensus of the FASB Emerging Issues Task Force.” ASU 2009-14 amends the scope of software revenue guidance in ASC Subtopic 985-605, “Software-Revenue Recognition,” to exclude tangible products containing software and non-software components that function together to deliver the product’s essential functionality. In October 2009, FASB also issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements (Topic 605) — a consensus of the FASB EITF.” ASU 2009-13 eliminates the residual method of allocation and requires the relative selling price method when allocating arrangement consideration to all deliverables at the inception of the arrangement. ASU 2009-13 specifies that the best estimate of a selling price is consistent with that used to determine the price to sell the deliverable on a standalone basis. ASU 2009-14 and ASU 2009-13 are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and must be adopted in the same period using the same transition method. If adoption is elected in a period other than the beginning of a fiscal year, the amendments in these standards must be applied retrospectively to the beginning of the fiscal year. Full retrospective application of these amendments to prior fiscal years is optional. We believe that the adoption of ASU 2009-14 and ASU 2009-13 will not have a significant impact on our consolidated financial statements.

 

3. Acquisition

 

NSPI

 

In June 2010, Sarcom, Inc, our wholly-owned subsidiary, completed the acquisition of substantially all of the assets of Network Services Plus, Inc. (“NSPI”). NSPI, primarily a provider of hosted data center and managed IT services in the southeastern United States, had approximately 73 employees as of the closing date, 53 of whom are billable IT resources. The terms of the transaction included an initial purchase price of $7.8 million, less a customary hold-back to settle possible indemnity claims. In addition, we extinguished substantially all of NSPI’s indebtedness that existed immediately prior to the closing date of our acquisition. We have recorded identifiable intangible assets of $2.6 million related to customer relationships, $0.5 million related to trademarks and $0.3 million related to a non-compete agreement, with estimated useful lives of 10, 10 and 4 years, respectively. In addition, pursuant to the terms of the asset purchase agreement, NSPI’s shareholders can earn additional consideration based on the performance of the NSPI business over the next two years, up to a total of approximately $5.2 million. In accordance with ASC 805, based on an initial valuation of the fair value of the contingent consideration, we recorded additional goodwill and a corresponding liability of $3.2 million for future earnout payments. Such valuation is based upon management’s initial forecasts of expected profitability of NSPI during the earnout period, and will be updated, if necessary, in future periods with adjustments reflected in our consolidated statement of operations.

 

6



 

4. Goodwill and Intangible Assets

 

Goodwill

 

Our goodwill, all of which is recorded in and held by our MME segment, totaled $25.5 million at June 30, 2010 and $19.3 million as of December 31, 2009. The $6.2 million of increase in goodwill from December 31, 2009 to June 30, 2010 was related to our acquisition of NSPI, which is discussed above, and is amortizable for income tax purposes over 15 years.

 

Intangible Assets

 

The following table sets forth the amounts recorded for intangible assets as of the periods presented (in thousands):

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

At June 30, 2010

 

At December 31, 2009

 

 

 

Useful Lives

 

Gross

 

Accumulated

 

Net

 

Gross

 

Accumulated

 

Net

 

 

 

(years)

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Amount

 

Patent, trademarks & URLs

 

9

 

$

6,328

(1)

$

572

 

$

5,756

 

$

5,878

(1)

$

557

 

$

5,321

 

Customer relationships

 

6

 

10,654

 

4,388

 

6,266

 

8,104

 

3,662

 

4,442

 

Non-compete agreements

 

4

 

1,168

 

434

 

734

 

918

 

327

 

591

 

Other

 

5

 

32

 

32

 

 

32

 

32

 

 

Total intangible assets

 

 

 

$

18,182

 

$

5,426

 

$

12,756

 

$

14,932

 

$

4,578

 

$

10,354

 

 


(1) Included in the total amount for “Patent, trademarks, & URLs” at June 30, 2010 and December 31, 2009 are $5.2 million of trademarks with indefinite useful lives acquired in the SARCOM acquisition that are not amortized.

 

Amortization expense for intangible assets was approximately $0.4 million for the three months ended June 30, 2010 and 2009 and approximately $0.8 million and approximately $0.7 million for the six months ended June 30, 2010 and 2009.

 

Estimated amortization expense for intangible assets in each of the next five years and thereafter is as follows: $1.0 million in the remainder of 2010; $2.0 million in 2011; $1.7 million in 2012; $0.8 million in 2013, $0.4 million in 2014 and $1.6 million thereafter.

 

5. Debt

 

We maintain an asset-based revolving credit facility, as amended from time to time, of up to $150 million from lending units of large commercial banks. The credit facility provides for, among other things, (i) a credit limit of $130 million up to a total maximum amount of $150 million, in increments of $5 million, provided that any increase of the total credit limit in excess of $130 million is subject to an acceptance by a third party assignee in the event the administrative agent elects to assign such excess amount; (ii) a line increase fee equal to 0.25% of the amount of each increment increased as described above, plus, to the extent that the administrative agent assigns a portion of its revolving loan commitment under the credit facility and to the extent required by the assignee, an aggregate acceptance fee not to exceed 0.125% of the aggregate sum of the increase in credit limit assigned; (iii) LIBOR interest rate options that we can enter into with no limit on the maximum outstanding principal balance which may be subject to a LIBOR interest rate option; and (iv) a maturity date of March 2011. In October 2008, we elected to increase our maximum credit line to $130 million from a previous maximum of $115 million.

 

The credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which 80% of the Maximum Credit, as defined in the agreement, then in effect, exceeds the average daily principal balance of the outstanding borrowings during the immediately preceding month. At June 30, 2010, we had $64.8 million of net working capital advances outstanding under the line of credit. At June 30, 2010, the maximum credit line was $130 million and we had $57.8 million available to borrow for working capital advances under the line of credit. There can be no assurance that the administrative agent, if electing to do so, will be successful in assigning the remaining excess $20 million of credit beyond the $130 million in any future period. As a result, we may not be able to access the credit facility beyond its current limit of $130 million and given the current credit market environment, we do not currently expect to be able to do so on our existing credit facility terms.

 

7



 

The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum tangible net worth requirement that is tested as of the last day of each fiscal quarter, which we were in compliance with at June 30, 2010. Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and utilization of early-pay discounts.

 

Our existing credit facility contains terms that are more favorable to us than terms that we believe would otherwise be available to us in the current credit market environment. We have been informed by the administrative agent for the facility that any amendment, modification, waiver, consent or other change we may seek with regard to our facility, including a consent to pursue an acquisition, will result in the renegotiation of the terms of the facility and would likely include terms less favorable to us, such as stricter financial covenants (such as covenants requiring us to maintain minimum levels of excess borrowing capacity or be subject to minimum fixed charge coverage ratios) and less favorable interest rates. These limitations could adversely affect our ability to make certain strategic investments or pursue certain acquisitions and other strategic transactions. Additionally, if market conditions have not improved by the time our current credit facility expires in March 2011, we expect that any new facility, to the extent available to us at such time, would be on terms less favorable to us than our existing credit facility.

 

In connection with and as part of the amended credit facility, we entered into an amended term note on September 17, 2007 with a principal balance of $5.425 million, payable in equal monthly principal installments beginning on October 1, 2007, plus interest at the prime rate with a LIBOR option. The amended term note matures in September 2014 or, in the event of a default, termination or non-renewal of our credit facility, is payable in its entirety upon demand by our lender. At June 30, 2010, we had $3.3 million outstanding under the amended term note. Our term note matures as follows: $387,500 in the remainder of 2010, $775,000 annually in each of the years 2011 through 2013 and $581,250 thereafter.

 

At June 30, 2010, our effective weighted average annual interest rate on outstanding amounts under the credit facility and term note was 1.85%.

 

As of June 30, 2010, $0.3 million relating to the financing of our purchase of Microsoft AX (Axapta), which is a part of our ERP upgrade, were included in each of our “Notes payable — current” and “Notes payable and other long-term liabilities” on our Consolidated Balance Sheets.

 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

6. Income Taxes

 

Accounting for Uncertainty in Income Taxes

 

ASC 740 clarifies the accounting for uncertainty in tax positions by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We had no unrecognized tax benefits and no accrued interest or penalties recognized as of the date of our adoption of ASC 740. During the three and six months ended June 30, 2010, there were no changes in our unrecognized tax benefits, and we had no accrued interest or penalties as of June 30, 2010.

 

We are subject to U.S. and foreign income tax examinations for years subsequent to 2005, and state income tax examinations for years following 2004. In addition, certain federal and state net operating loss carryforwards generated after 1998 and 1996, respectively, and used in a subsequent year, may still be adjusted by a taxing authority upon examination.

 

8



 

7. Earnings Per Share

 

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the reported periods. Diluted EPS reflects the potential dilution that could occur under the treasury stock method if stock options and other commitments to issue common stock were exercised, except in loss periods where the effect would be antidilutive. In addition, we exclude common stock options from the computation of diluted EPS when their exercise price is greater than the average market price of our common stock. As such, potential common shares of approximately 1,027,000 and 856,000 for the three months ended June 30, 2010 and 2009, and approximately 1,031,000 and 1,714,000 for the six months ended June 30, 2010 and 2009 have been excluded from the calculation of diluted EPS because the effect of their inclusion would be antidilutive.

 

The reconciliation of the amounts used in the basic and diluted EPS computation was as follows (in thousands, except per share amounts):

 

 

 

Income

 

Shares

 

Per Share
Amounts

 

Three Months Ended June 30, 2010:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,363

 

12,270

 

$

0.11

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

295

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,363

 

12,565

 

$

0.11

 

Three Months Ended June 30, 2009:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

815

 

12,296

 

$

0.07

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

378

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

815

 

12,674

 

$

0.06

 

Six Months Ended June 30, 2010:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,536

 

12,280

 

$

0.13

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

316

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,536

 

12,596

 

$

0.12

 

Six Months Ended June 30, 2009:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,826

 

12,356

 

$

0.15

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

264

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,826

 

12,620

 

$

0.14

 

 

8. Comprehensive Income

 

Our total comprehensive income was as follows for the periods presented (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income

 

$

1,363

 

$

815

 

$

1,536

 

$

1,826

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(292

)

427

 

(103

)

283

 

Total comprehensive income

 

$

1,071

 

$

1,242

 

$

1,433

 

$

2,109

 

 

9



 

9. Segment Information

 

Summarized segment information for our continuing operations for the periods presented is as follows (in thousands):

 

 

 

SMB

 

MME

 

Public Sector

 

MacMall

 

Corporate &
Other

 

Consolidated

 

Three Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

107,709

 

$

125,482

 

$

41,109

 

$

42,698

 

$

(15

)

$

316,983

 

Gross profit

 

14,678

 

18,639

 

2,586

 

4,720

 

(68

)

40,555

 

Depreciation and amortization expense (1)

 

4

 

679

 

55

 

109

 

1,055

 

1,902

 

Operating profit (loss)

 

7,648

 

6,015

 

(821

)

1,274

 

(11,269

)

2,847

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

85,267

 

$

92,410

 

$

37,958

 

$

45,776

 

$

1

 

$

261,412

 

Gross profit

 

11,598

 

15,771

 

3,796

 

4,625

 

47

 

35,837

 

Depreciation and amortization expense (1)

 

12

 

630

 

51

 

29

 

610

 

1,332

 

Operating profit (loss)

 

5,789

 

4,650

 

782

 

468

 

(9,732

)

1,957

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

215,703

 

$

221,973

 

$

85,124

 

$

84,032

 

$

5

 

$

606,837

 

Gross profit

 

28,075

 

35,120

 

6,215

 

9,181

 

(7

)

78,584

 

Depreciation and amortization expense (1)

 

8

 

1,332

 

107

 

197

 

2,087

 

3,731

 

Operating profit (loss)

 

14,032

 

10,629

 

(443

)

1,828

 

(22,423

)

3,623

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

174,771

 

$

177,340

 

$

65,198

 

$

103,395

 

$

8

 

$

520,712

 

Gross profit

 

22,879

 

31,642

 

7,479

 

11,257

 

75

 

73,332

 

Depreciation and amortization expense (1)

 

26

 

1,250

 

94

 

58

 

1,194

 

2,622

 

Operating profit (loss)

 

11,228

 

8,797

 

1,676

 

2,309

 

(19,993

)

4,017

 

 


(1)

 

Primary fixed assets relating to network and servers are managed by our corporate headquarters. As such, depreciation expense relating to such assets is included as part of Corporate and Other.

 

As of June 30, 2010 and December 31, 2009, we had total consolidated assets of $314.3 million and $301.2 million, respectively. Our management does not have available to them and does not use total assets measured at the segment level in allocating resources. Therefore, such information relating to segment assets is not provided herein.

 

10. Commitments and Contingencies

 

Total rent expense under our operating leases, net of sublease income, was $1.7 million and $1.5 million for the three months ended June 30, 2010 and 2009, and $3.3 million and $3.0 million for the six months ended June 30, 2010 and 2009. Some of our leases contain renewal options and escalation clauses, and require us to pay taxes, insurance and maintenance costs.

 

Legal Proceedings

 

From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation, including the litigation discussed above, could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

 

* * *

 

10



 

ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations together with the consolidated financial statements and related notes included elsewhere in this report, our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 16, 2010, as amended and filed on April 30, 2010, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 filed with the SEC on May 10, 2010, and all of our other periodic filings, including Current Reports on Form 8-K, filed with the SEC after the end of our 2009 fiscal year and through the date of this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described under “Forward-Looking Statements” below and under “Risk Factors” in Item 1A of Part II, and elsewhere in this report.

 

BUSINESS OVERVIEW

 

PC Mall, Inc., together with its wholly-owned subsidiaries (collectively referred to as “PC Mall,” “we” or “us”), founded in 1987, is a value added direct marketer of technology products, services and solutions to businesses, government and educational institutions and individual consumers. We offer our products, services and solutions through dedicated account executives, field service teams, various direct marketing techniques and three retail stores. We also utilize distinctive full-color catalogs under the PC Mall, MacMall, PC Mall Gov and SARCOM brands and our websites pcmall.com, macmall.com, pcmallgov.com, gmri.com, sarcom.com, abreon.com, nspi.com and onsale.com and other promotional materials.

 

PC Mall plays a valuable role in the IT supply chain. While we provide comprehensive solutions for our customers’ technology needs, our business model also provides significant leverage to technology manufacturers and service providers. Through us, technology manufacturers and service providers are able to reach multiple customer segments including consumers, small and medium sized businesses, large enterprise businesses, as well as state, local and federal governments and educational institutions. Our model also facilitates an efficient supply chain and support mechanism for manufacturers by using a combination of direct marketing, centralized selling and support and centralized product fulfillment. Additionally, while our experience and expertise in marketing and eCommerce allows us to efficiently reach and capture customers across these segments, our scale and centralized model allow us to efficiently deploy a one-to-many selling and delivery model.

 

We have four operating segments for financial reporting purposes, consisting of SMB, MME, Public Sector and MacMall. Our operating segments are primarily aligned based upon their respective customer base. We include corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our operating segments in Corporate and Other. We allocate our resources to and evaluate the performance of our segments based on operating income.

 

We experience variability in our net sales and operating results on a quarterly basis as a result of many factors. We experience some seasonal trends in our sales of technology products, services and solutions to businesses, government and educational institutions and individual customers. For example, the timing of capital budget authorizations for our customers in the small and medium sized business sector and the mid-market and enterprise sector can affect when these companies can procure IT products and services. The fiscal year-ends of Public Sector customers vary for those in the federal government space and those in the state and local government and educational institution (“SLED”) sector. We generally see an increase in our second quarter sales related to customers in the SLED sector and in our third quarter sales related to customers in the federal government space as these customers close out their budgets for their fiscal year. Also, consumer holiday spending contributes to variances in our quarterly results. As such, the results of interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year.

 

There has been substantial ongoing weakness in the global economic environment, coupled with disruptions in the capital and credit markets. General economic conditions have an effect on our business and results of operations across all of our segments. As a result of the ongoing tightness in the credit markets, softness in the housing market, difficulties in the financial services sector, general economic weakness and continuing economic uncertainties, the direction and relative strength of the U.S. economy has remained considerably uncertain. If economic growth in the U.S. and other countries’ economies slows or declines, consumer and business spending rates could be significantly reduced. These developments could also increase the risk of uncollectible accounts receivable from our customers. Continued and future changes and uncertainties in the economic climate in the U.S. and elsewhere could have a similar negative impact on the rate of information technology spending of our current and potential customers, which would likely have a negative impact on our

 

11



 

business and results of operations, and could significantly hinder our growth. These factors could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition, which could materially and adversely affect our business, results of operations and financial condition. In response to these developments, we have focused our efforts on cost reduction initiatives, competitive pricing strategies and driving higher margin service and solution sales, while continuing to make selective investments in our sales force personnel, service capabilities and IT infrastructure and tools in an effort to position us for enhanced productivity and future growth. We are currently engaged in an aggressive market share growth strategy in certain of our segments, which includes targeted aggressive pricing to acquire or enhance customer relationships as well as to enhance vendor relationships.

 

Our planned operating expenditures each quarter are based on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow gross margins may magnify the impact of these factors on our operating results. Management regularly reviews our operating performance using a variety of financial and non-financial metrics including sales, shipments, gross margin, vendor consideration, advertising expense, personnel costs, account executive productivity, accounts receivable aging, inventory turnover, liquidity and cash resources. Our management monitors the various metrics against goals and budgets, and makes necessary adjustments intended to enhance our performance.

 

A substantial portion of our business is dependent on sales of Apple, HP, and products purchased from other vendors including Adobe, Cisco, Ingram Micro, Lenovo, Microsoft, Sun Microsystems and Tech Data. Products manufactured by HP represented approximately 25% and 19% of our net sales in the three months ended June 30, 2010 and 2009, and 22% and 19% of our net sales in the six months ended June 30, 2010 and 2009. Products manufactured by Apple represented approximately 16% of our net sales in each of the three months ended June 30, 2010 and 2009, and 16% and 18% of our net sales in the six months ended June 30, 2010 and 2009.

 

One element of our business strategy involves expansion through the acquisition of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, or add new business capabilities. While we believe that the fragmented nature of the technology reseller industry and industry consolidation trends may continue to present acquisition opportunities for us, these continued trends may make acquisitions more competitive.

 

We evaluate acquisition opportunities based on our assessment of several factors, including the perceived value of the opportunity, our available financing sources, and potential synergies of the acquisition target with our business. Our ability to complete acquisitions in the future will depend on our ability to fund such acquisitions with our internally available cash, cash generated from operations, amounts available under our existing credit facilities, additional borrowings or from the issuance of additional securities. As more fully discussed under “Liquidity and Capital Resources” below, certain trends in our operating results may impact our available cash resources and availability under our credit facilities, which in turn may impact our ability to pursue our acquisition strategy.

 

STRATEGIC DEVELOPMENTS

 

ERP and Infrastructure Upgrades

 

We are currently upgrading many of our IT systems. We have purchased licenses for workflow software, web development tools and Microsoft Dynamics AX (Axapta) to upgrade our ERP systems. We initiated the implementation and upgrade of our eCommerce system in the second half of 2008 and have completed and launched a new generation of our public sites at macmall.com, onsale.com and pcmall.com. We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features. We completed the initial phase of the implementation in January 2010, and we expect to be complete with all phases of the implementation of the ERP systems by 2013. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. To date, we have incurred approximately $4.3 million of external and hardware costs, and approximately $1.4 million of internal capitalized labor costs related to the implementation of the ERP systems. In addition, based on our estimates, which are subject to change, we expect to incur approximately $5.0 million of additional external and hardware costs related to the implementation of the ERP systems. We also expect to incur material additional internal capitalized labor costs related to the ERP systems in the future.

 

In July 2008, we entered into an agreement with Cisco Systems for the purchase and implementation of various solutions to upgrade our current infrastructure for up to approximately $4.0 million. The purchase is financed through a capital lease over a five year term. Our plan is to provide a unified platform for our entire company and to provide a robust and efficient contact center. As of June 30, 2010, we have received $3.1 million of the Cisco solution. We expect to receive the remainder of the equipment and services in the second half of 2010. We are implementing the Cisco solution across all of our locations and expect that all of our locations will be upgraded by the first half of 2011.

 

12



 

NSPI Acquisition

 

In June 2010, Sarcom, Inc, our wholly-owned subsidiary, completed the acquisition of substantially all of the assets of Network Services Plus, Inc. (“NSPI”). NSPI, primarily a provider of hosted data center and managed IT services in the southeastern United States, had approximately 73 employees as of the closing date, 53 of whom are billable IT resources. The terms of the transaction included an initial purchase price of $7.8 million, less a customary hold-back to settle possible indemnity claims. In addition, we extinguished substantially all of NSPI’s indebtedness that existed immediately prior to the closing date of our acquisition. We have recorded identifiable intangible assets of $2.6 million related to customer relationships, $0.5 million related to trademarks and $0.3 million related to a non-compete agreement, with estimated useful lives of 10, 10 and 4 years, respectively. In addition, pursuant to the terms of the asset purchase agreement, NSPI’s shareholders can earn additional consideration based on the performance of the NSPI business over the next two years, up to a total of approximately $5.2 million. In accordance with ASC 805, based on an initial valuation of the fair value of the contingent consideration, we recorded additional goodwill and a corresponding liability of $3.2 million for future earnout payments. Such valuation is based upon management’s initial forecasts of expected profitability of NSPI during the earnout period, and will be updated, if necessary, in future periods with adjustments reflected in our consolidated statement of operations.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses, as well as the disclosure of contingent assets and liabilities. Management bases its estimates, judgments and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Due to the inherent uncertainty involved in making estimates, actual results reported for future periods may be affected by changes in those estimates, and revisions to estimates are included in our results for the period in which the actual amounts become known.

 

Management considers an accounting estimate to be critical if:

 

·                  it requires assumptions to be made that were uncertain at the time the estimate was made; and

 

·                  changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial position.

 

Management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our board of directors. We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a summary of our significant accounting policies, including those discussed below, see Note 2 of the Notes to the Consolidated Financial Statements in Item 8, Part II, of our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 16, 2010, as amended and filed on April 30, 2010.

 

13



 

Revenue Recognition. We adhere to the revised guidelines and principles of sales recognition described in ASC 605 (formerly Staff Accounting Bulletin No. 104, “Revenue Recognition,” issued by the staff of the SEC as a revision to Staff Accounting Bulletin No. 101, “Revenue Recognition”). Under ASC 605, product sales are recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed and determinable and collectability is reasonably assured. Under these guidelines, the majority of our sales, including revenue from product sales and gross outbound shipping and handling charges, are recognized upon receipt of the product by the customer. In accordance with our revenue recognition policy, we perform an analysis to estimate the number of days products we have shipped are in transit to our customers using data from our third party carriers and other factors. We record an adjustment to reverse the impact of sale transactions based on the estimated value of products that have shipped, but have not yet been received by our customers, and we recognize such amounts in the subsequent period when delivery has occurred. Changes in delivery patterns or unforeseen shipping delays beyond our control could have a material impact on our revenue recognition for the current period.

 

For all product sales shipped directly from suppliers to customers, we take title to the products sold upon shipment, bear credit risk, and bear inventory risk for returned products that are not successfully returned to suppliers; therefore, these revenues are recognized at gross sales amounts.

 

Certain software products and extended warranties that we sell (for which we are not the primary obligor) are recognized on a net basis in accordance with ASC 605-45 (formerly Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”). Accordingly, such revenues are recognized in net sales either at the time of sale or over the contract period, based on the nature of the contract, at the net amount retained by us, with no cost of goods sold.

 

Sales are reported net of estimated returns and allowances, discounts, mail-in rebate redemptions and credit card chargebacks. If the actual sales returns, allowances, discounts, mail-in rebate redemptions or credit card chargebacks are greater than estimated by management, additional expense may be incurred.

 

Allowance for Doubtful Accounts Receivable. We maintain an allowance for doubtful accounts receivable based upon estimates of future collection. We extend credit to our customers based upon an evaluation of each customer’s financial condition and credit history, and generally do not require collateral. We regularly evaluate our customers’ financial condition and credit history in determining the adequacy of our allowance for doubtful accounts. We also maintain an allowance for uncollectible vendor receivables, which arise from vendor rebate programs, price protections and other promotions. We determine the sufficiency of the vendor receivable allowance based upon various factors, including payment history. Amounts received from vendors may vary from amounts recorded because of potential non-compliance with certain elements of vendor programs. If the estimated allowance for uncollectible accounts or vendor receivables subsequently proves to be insufficient, additional allowance may be required.

 

Reserve for Inventory Obsolescence. We maintain an allowance for the valuation of our inventory by estimating obsolete or unmarketable inventory based on the difference between inventory cost and market value, which is determined by general market conditions, nature, age and type of each product and assumptions about future demand. We regularly evaluate the adequacy of our inventory reserve. If our inventory reserve subsequently proves to be insufficient, additional allowance may be required.

 

Mail-In Rebate Redemption Rate Estimates. We accrue monthly expense related to promotional mail-in rebates based upon the quantity of eligible orders transacted during the period and the estimated redemption rate. The estimated expense is accrued and presented as a reduction of net sales. The estimated redemption rates used to calculate the accrued mail-in rebate expense and related mail-in rebate liability are based upon historical redemption experience rates for similar products or mail-in rebate amounts. Estimated redemption rates and the related mail-in rebate expense and liability are regularly adjusted as actual mail-in rebate redemptions for the program are processed. If actual redemption rates are greater than anticipated, additional expense may be incurred.

 

Advertising Costs and Vendor Consideration. We account for advertising costs in accordance with ASC 340-20 (formerly Statement of Position No. 93-7, “Reporting on Advertising Costs”). We produce and circulate direct response catalogs at various dates throughout the year. The costs of developing, producing and circulating each direct response catalog are deferred, when warranted, and amortized to advertising expense based on the life of the catalog, which is approximately eight weeks. Other non-deferrable catalog and non-catalog advertising expenditures are expensed in the period incurred. Advertising expenditures are included in “Selling, general and administrative expenses” in our Consolidated Statements of Operations. Deferred advertising costs, if any, are included in “Prepaid expenses and other current assets” in our Consolidated Balance Sheets. At June 30, 2010 we had no deferred advertising costs, and at December 31, 2009 we had $0.3 million of deferred advertising costs on our Consolidated Balance Sheets.

 

14



 

We receive vendor consideration from our vendors in the form of cooperative marketing allowances, volume incentive rebates and other programs to support our marketing of their products. Most of our vendor consideration is accrued, when performance required for recognition is completed, as an offset to cost of sales in accordance with ASC 605-50 (formerly EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor”) since such funds are not a reimbursement of specific, incremental, identifiable costs incurred by us in selling the vendors’ products. As we circulate catalogs throughout the year, we also receive market development funds and other vendor consideration from vendors included in each catalog. These funds are deferred, when warranted, and recognized based on sales generated over the life of the catalog. Deferred vendor consideration is included in “Accrued expenses and other current liabilities” in our Consolidated Balance Sheets. At the end of any given period, unbilled receivables related to our vendor consideration are included in our “Accounts receivable, net of allowances.”

 

Stock-Based Compensation. Since January 1, 2006, we have accounted for stock-based compensation in accordance with ASC 718 (formerly financial Accounting Standards Board Statement No. 123 (revised 2004), “Share-Based Payment”), using the modified prospective application transition method. ASC 718 addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. ASC 718 generally requires that such transactions be accounted for using a fair value based method and recognized as expenses in our Consolidated Statements of Operations. The provisions of ASC 718 apply to new stock option grants subsequent to December 31, 2005 and unvested stock options outstanding as of January 1, 2006.

 

Pursuant to ASC 718, we estimate the grant date fair value of each stock option grant awarded pursuant to ASC 718 using the Black-Scholes option pricing model and management assumptions made regarding various factors, including expected volatility of our common stock, expected life of options granted and estimated forfeiture rates, which require extensive use of accounting judgment and financial estimates. In estimating our assumption regarding expected term for options we granted during the year ended December 31, 2007, we applied the simplified method set out in ASC 718 (which also includes former SEC Staff Accounting Bulletin No. 107, “Share-Based Payment,” which was issued in March 2005). For options granted during the six months ended June 30, 2010 and the years ended December 31, 2009 and 2008, we computed the expected term based upon an analysis of historical exercises of stock options by our employees. We compute our expected volatility using a frequency of weekly historical prices of our common stock for a period equal to the expected term of the options. The risk free interest rate is determined using the implied yield on U.S. Treasury issues with a remaining term within the contractual life of the award. We estimate an annual forfeiture rate based on our historical forfeiture data, which rate will be revised, if necessary, in future periods if actual forfeitures differ from those estimates. Any material change in the estimates used in calculating the stock-based compensation expense could result in a material impact on our results of operations.

 

Goodwill and Intangible Assets. Goodwill is carried at historical costs, subject to write-down, as needed, based upon an impairment analysis that we perform annually, or sooner if an event occurs or circumstances change that would more likely than not result in an impairment loss. We perform our annual impairment test for goodwill and indefinite lived intangible assets as of December 31 of each year. Under ASC 350 (formerly SFAS No. 142, “Goodwill and Other Intangible Assets”), goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. Events that may create an impairment review include, but are not limited to, significant and sustained decline in our stock price or market capitalization, significant underperformance of operating units and significant changes in market conditions. Changes in estimates of future cash flows or changes in market values could result in a write-down of our goodwill in a future period. If an impairment loss results from the annual impairment test, such loss will be recorded as a pre-tax charge to our operating income. We amortize other intangible assets with definite lives generally on a straight-line basis over their estimated useful lives.

 

15



 

RESULTS OF OPERATIONS

 

Consolidated Statements of Operations Data

 

The following table sets forth, for the periods indicated, our Consolidated Statements of Operations (in thousands, unaudited) and information derived from our Consolidated Statements of Operations expressed as a percentage of net sales. There can be no assurance that trends in our net sales, gross profit or operating results will continue in the future.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

$

316,983

 

$

261,412

 

$

606,837

 

$

520,712

 

Cost of goods sold

 

276,428

 

225,575

 

528,253

 

447,380

 

Gross profit

 

40,555

 

35,837

 

78,584

 

73,332

 

Selling, general and administrative expenses

 

37,708

 

33,880

 

74,961

 

69,315

 

Operating profit

 

2,847

 

1,957

 

3,623

 

4,017

 

Interest expense, net

 

507

 

324

 

989

 

688

 

Income before income taxes

 

2,340

 

1,633

 

2,634

 

3,329

 

Income tax expense

 

977

 

818

 

1,098

 

1,503

 

Net income

 

$

1,363

 

$

815

 

$

1,536

 

$

1,826

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold

 

87.2

 

86.3

 

87.1

 

85.9

 

Gross profit

 

12.8

 

13.7

 

12.9

 

14.1

 

Selling, general and administrative expenses

 

11.9

 

13.0

 

12.3

 

13.3

 

Operating profit

 

0.9

 

0.7

 

0.6

 

0.8

 

Interest expense, net

 

0.2

 

0.1

 

0.2

 

0.1

 

Income before income taxes

 

0.7

 

0.6

 

0.4

 

0.7

 

Income tax expense

 

0.3

 

0.3

 

0.2

 

0.3

 

Net income

 

0.4

%

0.3

%

0.2

%

0.4

%

 

Three Months Ended June 30, 2010 Compared to the Three Months Ended June 30, 2009

 

Net Sales. The following table presents our net sales, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

Change

 

 

 

2010

 

2009

 

$

 

%

 

SMB

 

$

107,709

 

$

85,267

 

$

22,442

 

26.3

%

MME

 

125,482

 

92,410

 

33,072

 

35.8

 

Public Sector

 

41,109

 

37,958

 

3,151

 

8.3

 

MacMall

 

42,698

 

45,776

 

(3,078

)

(6.7

)

Corporate and Other

 

(15

)

1

 

(16

)

NMF

(1)

Consolidated net sales

 

$

316,983

 

$

261,412

 

$

55,571

 

21.3

%

 


(1)     Not meaningful.

 

Our consolidated net sales for the second quarter of 2010 were $317.0 million, a $55.6 million or 21% increase from consolidated net sales of $261.4 million in the second quarter of 2009.

 

SMB segment net sales increased by $22.4 million, or 26%, to $107.7 million in the second quarter of 2010 from $85.3 million in the second quarter of 2009 primarily due to improved account executive productivity, an improvement in the demand environment and an increase in revenues from SMB’s new sales office located in Chicago.

 

16



 

Our MME segment net sales increased by $33.1 million, or 36%, to $125.5 million in the second quarter of 2010 from $92.4 million in the second quarter of 2009. This increase was primarily due to increased spending by customers in the mid-market and enterprise sector in the second quarter of 2010, which included a few large transactions with enterprise accounts.  Product revenues increased by 50% in the second quarter of 2010 compared to the second quarter of 2009 while service revenues decreased by 7% in the second quarter of 2010 compared to the second quarter of 2009. Service revenues represented 17% of MME net sales in the second quarter of 2010 compared to 25% of sales in the second quarter of 2009. The service revenue decline was primarily due to an 18% decline in MME’s Sarcom branded professional and managed services in the second quarter of 2010 compared to the second quarter of 2009 resulting from certain large service projects in the second quarter of 2009 that did not reoccur in the second quarter of 2010. The decline in service revenues was partially offset by a 14% increase in services performed under our Abreon brand, which is primarily focused on change management and eLearning consulting. MME’s service revenue vehicles are primarily contract-based and have longer lead times.

 

Our Public Sector segment net sales increased by $3.1 million, or 8%, to $41.1 million in the second quarter of 2010 from $38.0 million in the second quarter of 2009. This increase in Public Sector net sales was due to a 34% increase in net sales of our state and local government and educational institution business driven by stronger demand and our aggressive public sector market share growth strategy. These increases were partially offset by a 7% decrease in our federal government business due to reductions in sales of Sun Microsystems solutions, substantially related to the acquisition of Sun by Oracle and resulting vendor program changes in connection with Sun solutions. These changes also had a significant negative impact on our federal government net sales through a large contract vehicle.

 

Our MacMall segment net sales decreased by $3.1 million, or 7%, to $42.7 million in the second quarter of 2010 from $45.8 million in the second quarter of 2009. Sales in our MacMall segment declined primarily due to our previously announced intentional strategy shift in the first quarter of 2010 to focus the MacMall brand on higher profit customer segments such as small businesses, creative professionals and high-end consumers.

 

Gross Profit and Gross Profit Margin. The following table presents our gross profit and gross profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

Gross Profit

 

Change

 

 

 

Gross Profit

 

Margin

 

Gross Profit

 

Margin

 

$

 

Margin

 

SMB

 

$

14,678

 

13.6

%

$

11,598

 

13.6

%

$

3,080

 

0.0

%

MME

 

18,639

 

14.9

 

15,771

 

17.1

 

2,868

 

(2.2

)

Public Sector

 

2,586

 

6.3

 

3,796

 

10.0

 

(1,210

)

(3.7

)

MacMall

 

4,720

 

11.1

 

4,625

 

10.1

 

95

 

1.0

 

Corporate and Other

 

(68

)

NMF

 

47

 

NMF

 

(115

)

NMF

 

Consolidated gross profit and gross profit margin

 

$

40,555

 

12.8

%

$

35,837

 

13.7

%

$

4,718

 

(0.9

)%

 

Consolidated gross profit for the second quarter of 2010 was $40.6 million compared to $35.8 million in the second quarter of 2009, a $4.8 million or 13% increase. Consolidated gross profit margin was 12.8% in the second quarter of 2010 compared to 13.7% in the second quarter of 2009, a decrease of 90 basis points.

 

Gross profit for our SMB segment increased by $3.1 million, or 27%, to $14.7 million in the second quarter of 2010 compared to $11.6 million in the second quarter of 2009, resulting primarily from increased SMB net sales discussed above. SMB gross profit margin remained unchanged at 13.6% in the second quarter of 2010 compared to the second quarter of 2009 reflecting improvements due to seasonally strong enterprise software sales and a normalization of competitive pricing pressures, offset by a 71 basis point decline in vendor consideration as a percentage of net sales.

 

Gross profit for our MME segment increased by $2.8 million, or 18%, to $18.6 million in the second quarter of 2010 compared to $15.8 million in the second quarter of 2009, and gross profit margin decreased by 220 basis points to 14.9% in the second quarter of 2010 compared to 17.1% in the second quarter of 2009. The increase in MME gross profit was due to the increase in MME net sales discussed above. The decrease in MME gross profit margin was primarily due to the impact of the few large enterprise transactions mentioned above that were sold at lower margins, combined with the relative decreased mix of service sales during the quarter.

 

Gross profit for our Public Sector segment decreased by $1.2 million, or 32%, to $2.6 million in the second quarter of 2010 compared to $3.8 million in the second quarter of 2009, and gross profit margin decreased by 370 basis points to 6.3% in the second quarter of 2010 compared to 10.0% in the second quarter of 2009. The decrease in Public Sector gross profit and gross profit margin was primarily due to the impact of the Sun changes mentioned above. Gross profit margin also reflects our previously stated market share growth strategy in the Public Sector business, specifically on the Wintel platform in order to broaden our sales mix.

 

17



 

Gross profit for our MacMall segment increased by $0.1 million, or 2%, to $4.7 million in the second quarter of 2010 compared to $4.6 million in the second quarter of 2009, and gross profit margin increased by 100 basis points to 11.1% in the second quarter of 2009 compared to 10.1% in the second quarter of 2009. The increase in MacMall gross profit and MacMall gross profit margin was primarily due to our previously announced strategy shift to focus the MacMall brand on higher profit customer segments.

 

Operating Profit and Operating Profit Margin. The following table presents our operating profit and operating profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

 

 

 

Operating

 

 

 

Operating

 

 

 

 

 

 

 

Operating

 

Profit

 

Operating

 

Profit

 

Change

 

 

 

Profit (Loss)

 

Margin(1)

 

Profit (Loss)

 

Margin(1)

 

$

 

Margin

 

SMB

 

$

7,648

 

7.1

%

$

5,789

 

6.8

%

$

1,859

 

0.3

%

MME

 

6,015

 

4.8

 

4,650

 

5.0

 

1,365

 

(0.2

)

Public Sector

 

(821

)

(2.0

)

782

 

2.1

 

(1,603

)

(4.1

)

MacMall

 

1,274

 

3.0

 

468

 

1.0

 

806

 

2.0

 

Corporate and Other

 

(11,269

)

(3.6

)(1)

(9,732

)

(3.7

)(1)

(1,537

)

0.1

 

Consolidated operating profit and operating profit margin

 

$

2,847

 

0.9

%

$

1,957

 

0.7

%

$

890

 

0.2

%

 


(1)

 

Operating profit margin for Corporate and Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit increased by $0.9 million, or 45%, to $2.9 million in the second quarter of 2010 compared to $2.0 million in the second quarter of 2009. Consolidated operating profit margin for the second quarter of 2010 was 0.9% compared to 0.7% in the second quarter of 2009, an increase of 20 basis points.

 

Our SMB segment operating profit increased by $1.8 million, or 32%, to $7.6 million in the second quarter of 2010 compared to $5.8 million in the second quarter of 2009. The increase in SMB operating profit in the second quarter of 2010 was primarily due to the increase in SMB gross profit discussed above, partially offset by a $1.1 million increase in personnel costs. This increase in personnel costs in the second quarter of 2010 was primarily due to a $0.3 million impact of a higher Canadian exchange rate, the investment in our Chicago office and our addition of account executives in that facility, and an increase in variable commission and bonus expenses due to the increased SMB gross profit.

 

Our MME segment operating profit increased by $1.3 million, or 29%, to $6.0 million in the second quarter of 2010 compared to $4.7 million in the second quarter of 2009. The increase in MME operating profit was primarily due to the increase in MME gross profit discussed above, partially offset by a $0.9 million increase in personnel costs due in part to an increase in variable compensation costs related to the increased gross profit, a $0.2 million increase in bad debt expense and a $0.2 million increase in telecommunication expenses.

 

Our Public Sector segment had an operating loss of $0.8 million in the second quarter of 2010 compared to an operating profit of $0.8 million in the second quarter of 2009. The decrease in Public Sector operating profit from the second quarter of 2009 was primarily due to the decrease in Public Sector gross profit discussed above and an increase in Public Sector personnel costs of $0.4 million, resulting from our investment in our Public Sector’s Health Dynamix division and incremental investments in headcount. If the Sun Microsystems vendor program changes mentioned above are not modified from their current structure, or we are not able to sufficiently mitigate such changes, it could have a negative impact on our Public Sector sales, gross profit and operating profit in the future.

 

Our MacMall operating profit increased by $0.8 million to $1.3 million in the second quarter of 2010 compared to $0.5 million in the second quarter of 2009. The increase in MacMall operating profit was primarily due to a $0.7 million decrease in advertising expenditures and the $0.1 million increase in MacMall gross profit discussed above, each of which was facilitated by our strategy shift.

 

18



 

Corporate & Other operating expenses includes corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments. Second quarter 2010 Corporate & Other SG&A expenses increased by $1.6 million, or 16%, to $11.3 million from $9.7 million in the second quarter of 2009. The increase from the second quarter 2009 was primarily related to an increase in personnel costs of $0.6 million, which included $0.2 million increase in stock-based compensation expenses, and an increase in depreciation expenses of $0.4 million primarily related to the completed portions of our ERP and infrastructure upgrades. Results in the second quarter of 2010 also include approximately $0.2 million of legal costs associated with our acquisition of NSPI.

 

Net Interest Expense. Total net interest expense for the second quarter of 2010 increased to $0.5 million compared with $0.3 million in the second quarter of 2009. The increase in interest expense resulted primarily from an increase in our average total outstanding borrowings, partially offset by a decrease in our average effective borrowing rate in the second quarter of 2010 compared to the second quarter of 2009.

 

Income Tax Expense. We recorded an income tax expense of $1.0 million in the second quarter of 2010 compared to an income tax expense of $0.8 million in the second quarter of 2009. Our effective tax rates for the quarters ended June 30, 2010 and 2009 were approximately 42% and 50%. The decrease in our effective tax rate in the second quarter of 2010 compared to the second quarter of 2009 was primarily due to the impact of a tax adjustment relating to a dividend from an international subsidiary in the second quarter of 2009 that did not reoccur in 2010.

 

Six Months Ended June 30, 2010 Compared to the Six Months Ended June 30, 2009

 

Net Sales. The following table presents our net sales, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

Change

 

 

 

2010

 

2009

 

$

 

%

 

SMB

 

$

215,703

 

$

174,771

 

$

40,932

 

23.4

%

MME

 

221,973

 

177,340

 

44,633

 

25.2

 

Public Sector

 

85,124

 

65,198

 

19,926

 

30.6

 

MacMall

 

84,032

 

103,395

 

(19,363

)

(18.7

)

Corporate and Other

 

5

 

8

 

(3

)

NMF

 

Consolidated net sales

 

$

606,837

 

$

520,712

 

$

86,125

 

16.5

%

 

Our consolidated net sales for the six months ended June 30, 2010 were $606.8 million, an $86.1 million, or 17%, increase from consolidated net sales of $520.7 million in the six months ended June 30, 2009.

 

Our SMB segment net sales increased by $40.9 million, or 23%, to $215.7 million in the six months ended June 30, 2010 from $174.8 million in the six months ended June 30, 2009, primarily due to an improvement in the demand environment, an increase in revenues from SMB’s new sales office located in Chicago, combined with SMB’s aggressive market growth strategy.

 

Our MME segment net sales increased by $44.7 million, or 25%, to $222.0 million in the six months ended June 30, 2010 from $177.3 million in the six months ended June 30, 2009. This increase was primarily due to increased spending by customers in the mid-market and enterprise sector in the six months ended June 30, 2010, which included a few large transactions in the second quarter of 2010 with enterprise accounts. Product revenues increased by 39% in the six months ended June 30, 2010 compared to the same period in 2009 while service revenues decreased by 14% in the six months ended June 30, 2010 compared to the same period in 2009. Service revenues represented 18% of MME net sales in the six months ended June 30, 2010 compared to 26% of net sales in the six months ended June 30, 2009. The service revenue decline was primarily due to a 21% decline in MME’s Sarcom branded professional and managed services in the six months ended June 30, 2010 compared to the six months ended June 30, 2009 resulting from certain large service projects in the six months ended June 30, 2009 that did not reoccur in the six months ended June 30, 2010. Services performed under our Abreon brand, which is primarily focused on change management and eLearning consulting, remained unchanged for the six months ended June 30, 2010 compared to six months ended June 30, 2009. MME’s service revenue vehicles are primarily contract-based and have longer lead times.

 

19



 

Our Public Sector segment net sales increased by $19.9 million, or 31%, to $85.1 million in the six months ended June 30, 2010 compared to $65.2 million in the six months ended June 30, 2009. This increase was due to an increase in net sales in both our federal government business and our SLED business driven by stronger demand and our aggressive public sector market share growth strategy, as well as significant backlog from a large customer carried over from the fourth quarter of 2009. These increases were, however, partially offset by the impact of decreases in our federal government business due to reduction in sales of Sun Microsystems solutions, substantially related to the acquisition of Sun by Oracle and resulting vendor program changes in connection with Sun solutions. In addition, these changes had a significant negative impact on our federal government net sales through a large contract vehicle.

 

Our MacMall segment net sales decreased by $19.4 million, or 19%, to $84.0 million in the six months ended June 30, 2010 compared to $103.4 million in the six months ended June 30, 2009. This decrease in MacMall net sales was primarily due to our intentional strategy shift to focus the MacMall brand on higher profit customer segments such as small businesses, creative professionals and high end consumers. The decrease in MacMall net sales was also affected by continued competition in the market for Apple products and the absence of year end opportunistic purchases we made in 2008 which we were able to profitably sell in the first half of 2009.

 

Gross Profit and Gross Profit Margin. The following table presents our gross profit and gross profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

Gross Profit

 

Change

 

 

 

Gross Profit

 

Margin

 

Gross Profit

 

Margin

 

$

 

Margin

 

SMB

 

$

28,075

 

13.0

%

$

22,879

 

13.1

%

$

5,196

 

(0.1)

%

MME

 

35,120

 

15.8

 

31,642

 

17.8

 

3,478

 

(2.0

)

Public Sector

 

6,215

 

7.3

 

7,479

 

11.5

 

(1,264

)

(4.2

)

MacMall

 

9,181

 

10.9

 

11,257

 

10.9

 

(2,076

)

0.0

 

Corporate and Other

 

(7

)

NMF

 

75

 

NMF

 

(82

)

NMF

 

Consolidated gross profit and gross profit margin

 

$

78,584

 

12.9

%

$

73,332

 

14.1

%

$

5,252

 

(1.2

)%

 

Consolidated gross profit for the six months ended June 30, 2010 was $78.6 million compared to $73.3 million in the six months ended June 30, 2009, a $5.3 million or 7% increase. Consolidated gross profit margin was 12.9% in the six months ended June 30, 2010 compared to 14.1% in the six months ended June 30, 2009, a decrease of 120 basis points.

 

Gross profit for our SMB segment increased by $5.2 million, or 23%, to $28.1 for the six months ended June 30, 2010 compared to $22.9 million in the six months ended June 30, 2009 resulting primarily from increased SMB net sales discussed above. SMB segment gross profit margin decreased by 10 basis points to 13.0% in the six months ended June 30, 2010 compared to 13.1% in the six months ended June 30, 2009 primarily due to a competitive pricing environment and our aggressive SMB market share growth strategy.

 

Gross profit for our MME segment increased by $3.5million, or 11%, to $35.1 million in the six months ended June 30, 2010 compared to $31.6 million in the six months ended June 30, 2009, and gross profit margin decreased by 200 basis points to 15.8% in the six months ended June 30, 2010 compared to 17.8 % in the six months ended June 30, 2009. The increase in MME gross profit was primarily due to the increased MME net sales discussed above. The decrease in MME gross profit margin was primarily due to a competitive pricing environment, the impact of the few large enterprise transactions mentioned above that were sold at lower margins, combined with the relative decreased mix of service sales during the six months ended June 30, 2010.

 

Gross profit for our Public Sector segment decreased by $1.3 million, or 17%, to $6.2 million in the six months ended June 30, 2010 compared to $7.5 million in the six months ended June 30, 2009. Public Sector gross profit margin decreased by 420 basis points to 7.3% in the six months ended June 30, 2010 compared to 11.5% in the six months ended June 30, 2009. The decrease in our Public Sector gross profit and gross profit margin was primarily due to a higher mix of large, lower margin deals in the first half of 2010 and the impact of the Sun changes mentioned above. Gross profit margin for the six months ended June 30, 2010 also reflects our previously stated market share growth strategy in the Public Sector business, specifically on the Wintel platform in order to broaden our sales mix.

 

Gross profit for our MacMall segment decreased by $2.1 million, or 19%, to $9.2 million in the six months ended June 30, 2010 compared to $11.3 million in the six months ended June 30, 2009. MacMall gross profit margin remained flat at 10.9% in the six months ended June 30, 2010 and the six months ended June 30, 2009. The decrease in our MacMall gross profit was primarily due to the decrease in MacMall net sales discussed above. Our MacMall gross profit margin reflects the benefit of our previously announced strategy shift to focus the MacMall brand on higher profit customer segments.

 

20



 

Operating Profit and Operating Profit Margin. The following table presents our operating profit and operating profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

 

 

 

 

 

 

2010

 

2009

 

 

 

 

 

 

 

 

 

Operating

 

 

 

Operating

 

 

 

 

 

 

 

Operating

 

Profit

 

Operating

 

Profit

 

Change

 

 

 

Profit (Loss)

 

Margin(1)

 

Profit (Loss)

 

Margin(1)

 

$

 

Margin

 

SMB

 

$

14,032

 

6.5

%

$

11,228

 

6.4

%

$

2,804

 

0.1

%

MME

 

10,629

 

4.8

 

8,797

 

5.0

 

1,832

 

(0.2

)

Public Sector

 

(443

)

(0.5

)

1,676

 

2.6

 

(2,119

)

(3.1

)

MacMall

 

1,828

 

2.2

 

2,309

 

2.2

 

(481

)

0.0

 

Corporate and Other

 

(22,423

)

(3.7

)(1)

(19,993

)

(3.8

)(1)

(2,430

)

0.1

 

Consolidated operating profit and operating profit margin

 

$

3,623

 

0.6

%

$

4,017

 

0.8

%

$

(394

)

(0.2

)%

 


(1)

 

Operating profit margin for Corporate and Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit for the six months ended June 30, 2010 decreased by $0.4 million, or 10%, to $3.6 million compared to $4.0 million in the six months ended June 30, 2009. Consolidated operating profit margin for the six months ended June 30, 2010 was 0.6% compared to 0.8% in the six months ended June 30, 2009, a decrease of 20 basis points.

 

Our SMB segment operating profit increased by $2.8 million, or 25%, to $14.0 million in the six months ended June 30, 2010 compared to $11.2 million in the six months ended June 30, 2009. The increase was primarily due to the increase in SMB gross profit discussed above, partially offset by a $2.4 million increase in SMB personnel costs. This increase in personnel costs in the six months ended June 30, 2010 was primarily due to a $0.7 million impact of a higher Canadian exchange rate, the investment in our Chicago office and our addition of account executives in that facility, and an increase in variable commission and bonus expenses due to the increased SMB gross profit.

 

Our MME segment operating profit increased by $1.8 million, or 20%, to $10.6 million in the six months ended June 30, 2010 compared to $8.8 million in the six months ended June 30, 2009. The increase in MME operating profit was primarily due to the increase in MME gross profit discussed above, partially offset by a $1.1 million increase in MME personnel costs due in part to an increase in variable compensation costs related to the increased gross profit, a $0.3 million increase in telecommunication expenses and a $0.2 million increase in variable fulfillment costs.

 

Public Sector segment reported an operating loss of $0.4 million in the six months ended June 30, 2010 compared to an operating profit of $1.7 million in the six months ended June 30, 2009. The decrease in Public Sector operating profit from the six months ended June 30, 2009 was primarily due to the decrease in Public Sector gross profit discussed above and an increase in Public Sector personnel costs of $0.8 million, resulting from our investment in our Public Sector’s Health Dynamix division and incremental investments in headcount.

 

MacMall segment operating profit decreased by $0.5 million, or 21%, to $1.8 million in the six months ended June 30, 2010 compared to $2.3 million in the six months ended June 30, 2009. The decrease in MacMall segment operating profit was primarily due to the decrease in MacMall segment gross profit discussed above and a $0.4 million increase in personnel costs, partially offset by a $1.4 million decrease in advertising expenditures, a $0.4 million decrease in credit card related fees and a $0.4 million decrease in variable fulfillment costs.

 

Corporate and Other SG&A expenses increased by $2.4 million, or 12%, to $22.4 million in the six months ended June 30, 2010 from $20.0 million in the six months ended June 30, 2009. This increase was primarily due to a $1.1 million increase in personnel costs, which included $0.3 million increase in stock-based compensation expenses, and an increase in depreciation expenses of $0.9 million primarily related to the completed portions of our ERP and infrastructure upgrades. Results in the six months ended June 30, 2010 also include approximately $0.3 million of acquisition-related legal costs.

 

Net Interest Expense. Total net interest expense in the six months ended June 30, 2010 increased to $1.0 million compared with $0.7 million in the six months ended June 30, 2009. The increase in interest expense of $0.3 million resulted primarily from an increase in our average total outstanding borrowings in the six months ended June 30, 2010, partially offset by a decrease in our average effective borrowing rate in the six months ended June 30, 2010 compared to the same period in 2009.

 

21



 

Income Tax Expense. We recorded an income tax expense of $1.1 million in the six months ended June 30, 2010 compared to an income tax expense of $1.5 million in the six months ended June 30, 2009. Our effective tax rates for the six months ended June 30, 2010 and 2009 were approximately 42% and 45%. The decrease in our effective tax rate in the six months ended June 30, 2010 compared to the same period of 2009 was primarily due to the impact of a tax adjustment relating to a dividend from an international subsidiary in the six months ended June 30, 2009 that did not reoccur in 2010.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Working Capital. Our primary capital need has historically been funding the working capital requirements created by our growth in sales and strategic acquisitions. We expect that our primary capital needs will continue to be the funding of our existing working capital requirements, capital expenditures for which we expect to include substantial investments in a new ERP system, eCommerce platform and an upgrade of our current IT infrastructure over the next several years, which are discussed below in “Other Planned Capital Projects,” possible sales growth, possible acquisitions and new business ventures, and possible repurchases of our common stock under a discretionary repurchase program, which is discussed below. Our primary sources of financing have historically come from borrowings from financial institutions, public and private issuances of our common stock and cash flows from operations. Our efforts to focus on SMB, MME and Public Sector sales could result in an increase in our accounts receivable as these customers are generally provided longer payment terms than consumers. We historically have increased our inventory levels from time to time to take advantage of strategic manufacturer promotions. We believe that our current working capital, including our existing cash balance, together with our expected future cash flows from operations and available borrowing capacity under our line of credit, will be adequate to support our current operating plans for at least the next 12 months. However, the current macroeconomic environment and related competitive pricing pressure, which have negatively impacted our operating results, together with tight credit markets, may limit our cash resources that could otherwise be available to fund future strategic opportunities, capital investments or growth beyond our current operating plans.

 

There has been substantial ongoing weakness in the global economic environment, coupled with disruptions in the capital and credit markets. Continued problems in these areas could have a negative impact on our ability to obtain financing if we need additional funds, such as for acquisitions or expansion, to fund a significant downturn in our sales or an increase in our operating expenses, or to take advantage of opportunities or favorable market conditions, in the future. We may seek additional financing from public or private debt or equity issuances; however, there can be no assurance that such financing will be available at acceptable terms, if at all. Also, there can be no assurance that the cost or availability of future borrowings, if any, under our credit facility or in the debt markets will not be impacted by disruptions in the capital and credit markets.

 

We had cash and cash equivalents of $13.0 million at June 30, 2010 and $9.2 million at December 31, 2009. Our working capital was $43.0 million at June 30, 2010 and $54.0 million at December 31, 2009.

 

In October 2008, our Board of Directors approved a discretionary common stock repurchase program for up to $10 million of our common stock in aggregate with all other repurchases made under any repurchase programs following the date of such Board of Directors’ approval. This repurchase program effectively supersedes an existing repurchase program adopted in 1996. Under this new program, the shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. We expect that any repurchases of our common stock under this program will be financed with existing working capital and amounts available under our existing credit facility. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted. During the quarter ended June 30, 2010, we repurchased a total of 101,521 shares of our common stock under this program for a cost of approximately $500,000. From the inception of the program in October 2008 through June 30, 2010, we have repurchased an aggregate total of 1,436,681 shares of our common stock for a cost of $5.8 million. The repurchased shares are held as treasury stock.

 

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We maintain a Canadian call center serving the U.S. market, which has historically received the benefit of labor credits under a Canadian government program. In 2007, we received an eligibility certificate to participate in the Investment Quebec Refundable Tax Credit for Major Employment Generating Projects (GPCE), replacing the prior government subsidy program which ended at the end of 2007. In addition to other eligibility requirements under the new program, we are required to maintain a minimum of 317 eligible employees employed by our subsidiary PC Mall Canada, Inc. in the province of Quebec at all times to remain eligible to apply annually for these labor credits. As a result of this new certification, we are eligible to make annual labor credit claims for eligible employees equal to 25% of eligible salaries, but not to exceed $15,000 (Canadian) per eligible employee per year, beginning in fiscal year 2008 and continuing through fiscal year 2016. Under the prior program through the end of 2007, we claimed annual labor credits of up to 35% of eligible compensation paid to our qualifying employees. As of June 30, 2010, we had an accrued receivable of $7.8 million related to the 2008 and 2009 calendar years and we expect to receive full payment under our labor credit claims.

 

Cash Flows from Operating Activities. Net cash provided by operating activities was $9.2 million in the six months ended June 30, 2010 compared to $19.5 million in the six months ended June 30, 2009. The $9.2 million of net cash provided by operating activities in the six months ended June 30, 2010 was primarily due to a $15.7 million decrease in inventory reflecting the sell-through of seasonal purchases made in late 2009 as well as sell-through of our Public Sector segment backlog, partially offset by a $7.6 million increase in accounts receivable which was primarily due to the significant increase in our MME segment sales in the latter part of the second quarter of 2010. The $19.5 million of net cash provided by operating activities in the six months ended June 30, 2009 was primarily due to the $20.2 million decrease in inventory reflecting the sell-through of seasonal and strategic purchases made in late 2008, and a $16.7 million decrease in accounts receivable resulting from lower open account sales, partially offset by a $11.2 million decrease in gross accounts payable and an $8.0 million decrease in accrued expenses and other current liabilities.

 

Cash Flows from Investing Activities. Net cash used in investing activities was $13.2 million in the six months ended June 30, 2010 compared to $3.1 million in the six months ended June 30, 2009. The $13.2 million of net cash used in investing activities in the six months ended June 30, 2010 was related to the $8.8 million (net of cash acquired) used for the acquisition of NSPI in June 2010 and $4.4 million of capital expenditures. The $4.4 million of capital expenditures were primarily related to investments in our IT infrastructure, leasehold improvements relating to our relocated retail store in Torrance, California and the creation of enhanced electronic tools for our account executives and sales support staff. The $3.1 million of net cash used in investing activities in the six months ended June 30, 2009 was related to capital expenditures, which were primarily related to investment in our IT infrastructure, including ERP, security and telecommunications upgrades.

 

Cash Flows from Financing Activities. Net cash provided by financing activities for the six months ended June 30, 2010 was $7.9 million compared to net cash used in financing activities of $19.4 million in the six months ended June 30, 2009. The $7.9 million of net cash provided by financing activities in the six months ended June 30, 2010 was primarily due to the $11.7 million of net borrowings on our line of credit, of which $9.8 million was related to our acquisition of NSPI, partially offset by a $2.4 million change in book overdraft. The $19.4 million of net cash used in financing activities in the six months ended June 30, 2009 was primarily due to the $15.0 million of net payments made on the outstanding balance of our line of credit and a $2.9 million change in book overdraft.

 

Line of Credit and Note Payable. We maintain an asset-based revolving credit facility, as amended from time to time, of up to $150 million from lending units of large commercial banks. The credit facility provides for, among other things, (i) a credit limit of $130 million up to a total maximum amount of $150 million, in increments of $5 million, provided that any increase of the total credit limit in excess of $130 million is subject to an acceptance by a third party assignee in the event the administrative agent elects to assign such excess amount; (ii) a line increase fee equal to 0.25% of the amount of each increment increased as described above, plus, to the extent that the administrative agent assigns a portion of its revolving loan commitment under the credit facility and to the extent required by the assignee, an aggregate acceptance fee not to exceed 0.125% of the aggregate sum of the increase in credit limit assigned; (iii) LIBOR interest rate options that we can enter into with no limit on the maximum outstanding principal balance which may be subject to a LIBOR interest rate option; and (iv) a maturity date of March 2011. In October 2008, we elected to increase our maximum credit line to $130 million from a previous maximum of $115 million.

 

The credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which 80% of the Maximum Credit, as defined in the agreement, then in effect, exceeds the average daily principal balance of the outstanding borrowings during the immediately preceding month. At June 30, 2010, we had $64.8 million of net working capital advances outstanding under the line of credit. At June 30, 2010, the maximum credit line was $130 million and we had $57.8 million available to borrow for working capital advances under the line of credit. There can be no assurance that the administrative agent, if electing to do so, will be successful in assigning the remaining excess $20 million of credit beyond the $130 million in any future period. As a result, we may not be able to access the credit facility beyond its current limit of $130 million and given the current credit market environment, we do not currently expect to be able to do so on our existing credit facility terms.

 

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The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum tangible net worth requirement that is tested as of the last day of each fiscal quarter, which we were in compliance with at June 30, 2010. Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and utilization of early-pay discounts.

 

Our existing credit facility contains terms that are more favorable to us than terms that we believe would otherwise be available to us in the current credit market environment. We have been informed by the administrative agent for the facility that any amendment, modification, waiver, consent or other change we may seek with regard to our facility, including a consent to pursue an acquisition, will result in the renegotiation of the terms of the facility and would likely include terms less favorable to us, such as stricter financial covenants (such as covenants requiring us to maintain minimum levels of excess borrowing capacity or be subject to minimum fixed charge coverage ratios) and less favorable interest rates. These limitations could adversely affect our ability to make certain strategic investments or pursue certain acquisitions and other strategic transactions. Additionally, if market conditions have not improved by the time our current credit facility expires in March 2011, we expect that any new facility, to the extent available to us at such time, would be on terms less favorable to us than our existing credit facility.

 

In connection with and as part of the amended credit facility, we entered into an amended term note on September 17, 2007 with a principal balance of $5.425 million, payable in equal monthly principal installments beginning on October 1, 2007, plus interest at the prime rate with a LIBOR option. The amended term note matures in September 2014 or, in the event of a default, termination or non-renewal of our credit facility, is payable in its entirety upon demand by our lender. At June 30, 2010, we had $3.3 million outstanding under the amended term note. Our term note matures as follows: $387,500 in the remainder of 2010, $775,000 annually in each of the years 2011 through 2013 and $581,250 thereafter.

 

At June 30, 2010, our effective weighted average annual interest rate on outstanding amounts under the credit facility and term note was 1.85%.

 

As of June 30, 2010, $0.3 million relating to the financing of our purchase of Microsoft AX (Axapta), which is a part of our ERP upgrade, were included in each of our “Notes payable — current” and “Notes payable and other long-term liabilities” on our Consolidated Balance Sheets. See “Other Planned Capital Projects” below for a detailed discussion.

 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

As part of our growth strategy, we may, in the future, make acquisitions in the same or complementary lines of business, and pursue other business ventures. Any launch of a new business venture or any acquisition and the ensuing integration of the acquired operations would place additional demands on our management, and our operating and financial resources.

 

Other Planned Capital Projects

 

We are currently upgrading many of our IT systems. We have purchased licenses for workflow software, web development tools and Microsoft Dynamics AX (Axapta) to upgrade our ERP systems. We initiated the implementation and upgrade of our eCommerce system in the second half of 2008 and have completed and launched a new generation of our public sites at macmall.com, onsale.com and pcmall.com. We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features. We completed the initial phase of the implementation in January 2010, and we expect to be complete with all phases of the implementation of the ERP systems by 2013. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. To date, we have incurred approximately $4.3 million of external and hardware costs, and approximately $1.4 million of internal capitalized labor costs related to the implementation of the ERP systems. In addition, based on our estimates, which are subject to change, we expect to incur approximately $5.0 million of additional external and hardware costs related to the implementation of the ERP systems. We also expect to incur material additional internal capitalized labor costs related to the ERP systems in the future.

 

In July 2008, we entered into an agreement with Cisco Systems for the purchase and implementation of various solutions to upgrade our current infrastructure for up to approximately $4.0 million. The purchase is financed through a capital lease over a five year term. Our plan is to provide a unified platform for our entire company and to provide a robust and efficient contact center. As of June 30, 2010, we have received $3.1 million of the Cisco solution. We expect to receive the remainder of the equipment and services in the second half of 2010. We are implementing the Cisco solution across all of our locations and expect that all of our locations will be upgraded by the first half of 2011.

 

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Inflation

 

Inflation has not had a material impact on our operating results; however, there can be no assurance that inflation will not have a material impact on our business in the future.

 

Dividend Policy

 

We have never paid cash dividends on our capital stock and our credit facility prohibits us from paying any cash dividends on our capital stock. Therefore, we do not currently anticipate paying dividends; we intend to retain any earnings to finance the growth and development of our business.

 

Off-Balance Sheet Arrangements

 

As of June 30, 2010, we did not have any off-balance sheet arrangements.

 

Contingencies

 

For a discussion of contingencies, see Part I, Item 1, Note 10 of the Notes to the Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

 

For a discussion of recent accounting pronouncements, see Part I, Item 1, Note 2 of the Notes to the Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements include statements regarding our expectations, hopes or intentions regarding the future, including but not limited to, statements regarding our strategies, competition, markets, vendors, expenses, new services and technologies, growth prospects, financing, revenue, margins, operations, litigation and compliance with applicable laws. In particular, the following types of statements are forward-looking:

 

·             the impact of changes in vendor programs or other vendor assistance on our operating results;

·             the impact of strategic investments, including our investment in our Chicago call center, our Health Dynamix division, our IT infrastructure, the PC Mall Small Business Network;

·             our expectation regarding general economic uncertainties, the competitive pricing pressure in the current environment and the related potential negative impact on our gross profit margins;

·             our beliefs relating to the benefits to be received from our Philippines office and Canadian call center, including tax credits and reduction in labor costs over time;

·             our use of management information systems and their need for future support or upgrade;

·             our expectations regarding the timing and costs of our ongoing or planned IT upgrades;

·             our plans for our growth strategies, including our market share growth strategies and our refined MacMall strategy;

·             our expectations regarding our future capital needs and the availability of working capital, liquidity, cash flows from operations and borrowings under our credit facility;

·             the impact of changes in our mix of products and services in our MME segment on our operating results;

·             the impact on accounts receivable from our efforts to focus on sales in our MME, SMB, and Public Sector segments;

·             our acquisition strategy and the impact of any past or future acquisitions;

·             the impact of acquisitions on our financial condition, liquidity and our future cash flows and earnings;

·             our ability to execute our business strategies;

·             our competitive advantages and growth opportunities;

·             our ability to increase profitability and revenues;

·             our beliefs regarding the applicability of tax regulations;

·             our belief regarding our exposure to currency exchange and interest rate risks;

 

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·             our belief regarding the effect of seasonal trends and general economic conditions on our business and results of operations across all of our segments;

·             our expectations regarding the impact of accounting pronouncements;

·             our expectations regarding the payment of dividends and our intention to retain any earnings to finance the growth and development of our business;

·             our ability to attract new customers and stimulate additional purchases from existing customers, including our expectations regarding future advertising levels and the effect on consumer sales;

·             our belief regarding financing of repurchases of our common stock;

·             our ability to limit risk related to price reductions;

·             our expectations regarding competition and the industry trend toward consolidation;

·             our compliance with laws and regulations; and

·             the likelihood that new laws and regulations will be adopted with respect to the Internet that may impose additional restrictions or burdens on our business.

 

Forward-looking statements involve certain risks and uncertainties, and actual results may differ materially from those discussed in any such statement. Factors that could cause actual results to differ materially from such forward-looking statements include the risks described in greater detail under the heading “Risk Factors” in Part II, Item 1A of this report. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and, except as otherwise required by law, we assume no obligation to update or revise any forward-looking statement or other information contained herein to reflect new information, events or circumstances after the date hereof.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our financial instruments include cash and cash equivalents and long-term debt. At June 30, 2010, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.

 

We have not entered into derivative financial instruments as of June 30, 2010. However, from time-to-time, we contemplate and may enter into derivative financial instruments related to interest rate, foreign currency, and other market risks.

 

Interest Rate Risk

 

We have exposure to the risks of fluctuating interest rates on our line of credit and note payable. The variable interest rates on our line of credit and note payable are tied to the prime rate or the LIBOR, at our discretion. At June 30, 2010, we had $64.8 million outstanding under our line of credit and $3.3 million outstanding under our note payable. As of June 30, 2010, the hypothetical impact of a one percentage point increase in interest rate related to the outstanding borrowings under our line of credit and note payable would be to increase our annual interest expense by approximately $0.7 million.

 

Foreign Currency Exchange Risk

 

We have operation centers in Canada and the Philippines that provide back-office administrative support and customer service support. In each of these countries, transactions are primarily conducted in the respective local currencies. In addition, our two foreign subsidiaries that operate the operation centers have intercompany accounts with our U.S. subsidiaries that eliminate upon consolidation. However, transactions resulting in such accounts expose us to foreign currency rate fluctuations. We record gains and losses resulting from exchange rate fluctuations on our short-term intercompany accounts in “Selling, general and administrative expenses” in our Consolidated Statements of Operations and translation gains and losses resulting from exchange rate fluctuations on local currency based assets and liabilities in “Accumulated other comprehensive income,” a separate component of stockholders’ equity on our Consolidated Balance Sheets. As such, we have foreign currency translation exposure for changes in exchange rates for these currencies. As of June 30, 2010, we did not have material foreign currency or overall currency exposure. Significant changes in exchange rates between foreign currencies in which we transact business and the U.S. dollar may adversely affect our Consolidated Statements of Operations and Consolidated Balance Sheets.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2010.

 

Changes in Internal Control Over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the second quarter of 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not currently a party to any material legal proceedings, other than ordinary routine litigation incidental to the business. From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

 

ITEM 1A. RISK FACTORS

 

This report and other documents we file with the Securities and Exchange Commission contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business, our beliefs and our management’s assumptions. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. We have set forth the risk factors that relate to our business, as set forth below. These risks include any material changes to and supersede the risks previously disclosed in Part II, Item 1A of our Quarterly Report on Form 10-Q for the period ended March 31, 2010. You should carefully consider the risks and uncertainties facing our business which are set forth below. The risks described below are not the only ones facing us. Our business is also subject to risks that affect many other companies, such as employment relations, general economic conditions, geopolitical events and international operations. Further, additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity and stock price materially and adversely.

 

Changes and uncertainties in the economic climate could negatively affect the rate of information technology spending by our customers, which would likely have an impact on our business.

 

An important element of our business strategy is to increasingly focus on SMB, MME and Public Sector sales. As a result of the ongoing tightness in the credit markets, softness in the housing market, difficulties in the financial services sector, general economic weakness and continuing economic uncertainties, the direction and relative strength of the U.S. economy remains considerably uncertain. These factors could also increase the risk of uncollectible accounts receivable from our customers. During the recent economic downturns in the U.S. and elsewhere, SMB, MME and Public Sector entities generally reduced, often substantially, their rate of information technology spending. Weak economic conditions and consumer confidence has also resulted in a decline in consumer spending on technology and related consumer goods. Continued and future changes and uncertainties in the economic climate in the U.S. and elsewhere could have a similar negative impact on the rate of information technology spending of our current and potential customers, which would likely have a negative impact on our business and results of operations, and could significantly hinder our growth.

 

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Our earnings and growth rate could be adversely affected by continued changes in economic and geopolitical conditions.

 

We are subject to risks arising from adverse changes in domestic and global economic conditions. If economic growth in the United States and other countries’ economies continues to slow or declines, consumer and business spending rates could be significantly reduced. This could result in reductions in sales of our products, longer sales and payment cycles, slower adoption of new technologies and increased price competition, any of which could materially and adversely affect our business, results of operations and financial condition. Weak general economic conditions, along with uncertainties in political conditions could adversely impact our revenue, expenses and growth rate. In addition, our revenue, gross margins and earnings could deteriorate in the future as a result of unfavorable economic or geopolitical conditions.

 

Certain of our vendors provide us with incentives and other assistance that reduce our operating costs, and any decline in these incentives and other assistance could materially harm our operating results.

 

Certain of our vendors, including Adobe, Apple, Cisco, HP, IBM, Ingram Micro, Lenovo, Microsoft, Sony, Sun Microsystems and Tech Data, provide us with trade credit or substantial incentives in the form of discounts, credits and cooperative advertising. We have agreements with many of our vendors under which they provide us, or they have otherwise consistently provided us, with market development funds to finance portions of our catalog publication and distribution costs based upon the amount of coverage we give to their respective products in our catalogs or other advertising mediums. Any termination or interruption of our relationships with one or more of these vendors, particularly Apple or HP, or modification of the terms or discontinuance of our agreements and market development fund programs and arrangements with these vendors, could adversely affect our operating income and cash flow. For example, the amount of vendor consideration we receive from a particular vendor may be impacted by a number of events outside of our control, including acquisitions, management changes or economic pressures affecting such vendor, any of which could materially affect the amount of vendor consideration we receive from such vendor.

 

Our revenue is dependent on sales of products from a small number of key manufacturers, and a decline in sales of products from these manufacturers could materially harm our business.

 

Our revenue is dependent on sales of products from a small number of key manufacturers and software publishers, including Apple, HP, IBM, Lenovo, Microsoft and Sony. For example, products manufactured by HP represented approximately 25% and 19%of our net sales for the three months ended June 30, 2010 and 2009. Products manufactured by Apple represented approximately 16% of our net sales in each of the three months ended June 30, 2010 and 2009. A decline in sales of any of our key manufacturers’ products, whether due to decreases in supply of or demand for their products, termination of any of our agreements with them, or otherwise, could have a material adverse impact on our sales and operating results.

 

We do not have long-term supply agreements or guaranteed price or delivery arrangements with our vendors.

 

In most cases we have no guaranteed price or delivery arrangements with our vendors. As a result, we have experienced and may in the future experience inventory shortages on certain products. Furthermore, our industry occasionally experiences significant product supply shortages and customer order backlogs due to the inability of certain manufacturers to supply certain products as needed. We cannot assure you that suppliers will maintain an adequate supply of products to fulfill our orders on a timely basis, or at all, or that we will be able to obtain particular products on favorable terms or at all. Additionally, we cannot assure you that product lines currently offered by suppliers will continue to be available to us. A decline in the supply or continued availability of the products of our vendors, or a significant increase in the price of those products, could reduce our sales and negatively affect our operating results.

 

Substantially all of our agreements with vendors are terminable within 30 days.

 

Substantially all of our agreements with vendors are terminable upon 30 days’ notice or less. For example, while we are an authorized dealer for the full retail line of HP and Apple products, HP and Apple can terminate our dealer agreements upon 30 days’ notice. Vendors that currently sell their products through us could decide to sell, or increase their sales of, their products directly or through other resellers or channels. Any termination, interruption or adverse modification of our relationship with a key vendor or a significant number of other vendors would likely adversely affect our operating income, cash flow and future prospects.

 

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Our success is dependent in part upon the ability of our vendors to develop and market products that meet changes in marketplace demand, as well as our ability to sell popular products from new vendors.

 

The products we sell are generally subject to rapid technological change and related changes in marketplace demand. Our success is dependent in part upon the ability of our vendors to develop and market products that meet these changes in marketplace demand. Our success is also dependent on our ability to develop relationships with and sell products from new vendors that address these changes in marketplace demand. To the extent products that address changes in marketplace demand are not available to us, or are not available to us in sufficient quantities or on acceptable terms, we could encounter increased price and other competition, which would likely adversely affect our business, financial condition and results of operations.

 

We may not be able to maintain existing or build new vendor relationships, which may affect our ability to offer a broad selection of products at competitive prices and negatively impact our results of operations.

 

We purchase products for resale both directly from manufacturers and indirectly through distributors and other sources, all of whom we consider our vendors. We also maintain certain qualifications and preferred provider status with several of our vendors, which provides us with preferred pricing, vendor training and support, preferred access to products, and other significant benefits. While these vendor relationships are an important element of our business, we do not have long-term agreements with any of these vendors. Any agreements with vendors governing our purchase of products are generally terminable by either party upon 30 days’ notice or less. In general, we agree to offer products through our catalogs and on our websites and the vendors agree to provide us with information about their products and honor our customer service policies. If we do not maintain our existing relationships or build new relationships with vendors on acceptable terms, including favorable product pricing and vendor consideration, we may not be able to offer a broad selection of products or continue to offer products at competitive prices. In addition, some vendors may decide not to offer particular products for sale on the Internet, and others may avoid offering their new products to retailers offering a mix of close-out and refurbished products in addition to new products. From time to time, vendors may be acquired by other companies, terminate our right to sell some or all of their products, modify or terminate our preferred provider or qualification status, change the applicable terms and conditions of sale or reduce or discontinue the incentives or vendor consideration that they offer us. Any such termination or the implementation of such changes, or our failure to build new vendor relationships, could have a negative impact on our operating results. Additionally, some products are subject to manufacturer or distributor allocation, which limits the number of units of those products that are available to us and may adversely affect our operating results.

 

Our narrow gross margins magnify the impact of variations in our operating costs and of adverse or unforeseen events on our operating results.

 

We are subject to intense price competition with respect to the products we sell. As a result, our gross margins have historically been narrow, and we expect them to continue to be narrow. As a result of the recent economic downturn, we have experienced increasing price competition, which has had a negative impact on our gross margins. Our narrow gross margins magnify the impact of variations in our operating costs and of adverse or unforeseen events on our operating results. Future increases in costs such as the cost of merchandise, wage levels, shipping rates, freight costs and fuel costs may negatively impact our margins and profitability. We are not always able to raise the sales price of our merchandise to offset cost increases. If we are unable to maintain our gross margins in the future, it could have a material adverse effect on our business, financial condition and results of operations. In addition, because price is an important competitive factor in our industry, we cannot assure you that we will not be subject to increased price competition in the future. If we become subject to increased price competition in the future, we cannot assure you that we will not lose market share, that we will not be forced to reduce our prices and further reduce our gross margins, or that we will be able to compete effectively.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors.  These factors include:

 

·                  the general economic environment and competitive conditions, such as pricing;

·                  variability in vendor programs;

·                  the timing of procurement cycles by our business, government and educational institution customers;

·                  seasonality in consumer spending;

·                  the frequency of our catalog mailings, introduction or discontinuation of new catalogs;

·                  the introduction of new products or services by us and our competitors;

 

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·                  changes in prices from our suppliers;

·                  promotions;

·                  the loss or consolidation of significant suppliers or customers;

·                  our ability to control costs;

·                  the timing of our capital expenditures;

·                  the condition of our industry in general;

·                  seasonal shifts in demand for computer and electronics products;

·                  industry announcements and market acceptance of new products or upgrades;

·                  deferral of customer orders in anticipation of new product applications;

·                  product enhancements or operating systems;

·                  the relative mix of products sold during the period;

·                  any inability on our part to obtain adequate quantities of products carried in our catalogs;

·                  delays in the release by suppliers of new products and inventory adjustments;

·                  our expenditures on new business ventures and acquisitions;

·                  performance of acquired businesses;

·                  adverse weather conditions that affect response;

·                  distribution or shipping to our customers; and

·                  geopolitical events.

 

Our planned operating expenditures each quarter are based on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow gross margins may magnify the impact of these factors on our operating results. We believe that period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. In addition, our results in any quarterly period are not necessarily indicative of results to be expected for a full fiscal year. In future quarters, our operating results may be below the expectations of public market analysts or investors and as a result the market price of our common stock could be materially adversely affected.

 

The transition of our business strategy to increasingly focus on SMB, MME and Public Sector sales presents numerous risks and challenges, and may not improve our profitability or result in expanded market share.

 

An important element of our business strategy is to increasingly focus on SMB, MME and Public Sector sales. In shifting our focus, we face numerous risks and challenges, including competition from a wider range of sources and an increased need to develop strategic relationships. We cannot assure you that our increased focus on SMB, MME and Public Sector sales will result in expanded market share or increased profitability. Furthermore, revenue from our public sector business is derived from sales to federal, state and local governmental departments and agencies, as well as to educational institutions, through various contracts and open market sales. Government contracting is a highly regulated area, and noncompliance with government procurement regulations or contract provisions could result in civil, criminal, and administrative liability, including substantial monetary fines or damages, termination of government contracts, and suspension, debarment or ineligibility from doing business with the government. The effect of any of these possible actions by any governmental department or agency with which we contract could adversely affect our business and results of operations. Moreover, contracting with governmental departments and agencies involves additional risks, such as longer payment terms, limited recourse against the government agency in the event of a business dispute, the potential lack of a limitation of our liability for damages from our provision of services to the department or agency, and the potential for changes in statutory or regulatory provisions that negatively affect the profitability of such contracts.

 

Our investments in our outbound phone-based sales force model may not improve our profitability or result in expanded market share.

 

We have made and are currently making efforts to increase our market share by investing in training and retention of our outbound phone-based sales force. We have also incurred, and expect to continue to incur, significant expenses resulting from infrastructure investments related to our outbound phone-based sales force. We cannot assure you that any of our investments in our outbound phone-based sales force will result in expanded market share or increased profitability in the near or long term.

 

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Our financial performance could be adversely affected if we are not able to retain and increase the experience of our sales force or if we are not able to maintain or increase their productivity.

 

Our sales and operating results may be adversely affected if we are unable to increase the average tenure of our account executives or if the sales volumes and profitability achieved by our account executives do not increase with their increased experience.

 

Existing or future government and tax regulations could expose us to liabilities or costly changes in our business operations, and could reduce demand for our products and services.

 

Based upon current interpretations of existing law, certain of our subsidiaries currently collect and remit sales or use tax only on sales of products or services to residents of the states in which the respective subsidiaries have a physical presence or have voluntarily registered for sales tax collection. The U.S. Supreme Court has ruled that states, absent Congressional legislation, may not impose tax collection obligations on an out-of-state direct marketer whose only contacts with the taxing state are distribution of catalogs and other advertisement materials through the mail, and whose subsequent delivery of purchased goods is by mail or interstate common carriers. However, we cannot predict the level of contact with any state which would give rise to future or past tax collection obligations. Additionally, it is possible that federal legislation could be enacted that would permit states to impose sales or use tax collection obligations on out-of-state direct marketers. Furthermore, court cases have upheld tax collection obligations on companies, including mail order companies, whose contacts with the taxing state were quite limited (e.g., visiting the state several times a year to aid customers or to inspect stores stocking their goods or to provide training or other support to customers in the state). States have also successfully imposed sales and use tax collection responsibility upon in-state manufacturers that agree to act as a drop shipper for the out-of-state marketer, giving rise to the risk that such taxes may be imposed indirectly on the out-of-state seller. We believe our operations in states in which we have no physical presence are different from the operations of the companies in those cases and are thus not subject to the tax collection obligations imposed by those decisions. Various state laws, regulations and taxing authorities have sought to impose on direct marketers with no physical presence in the taxing state the burden of collecting state sales and use taxes on the sale of products shipped or services sold to those states’ residents, and it is possible that such a requirement could be imposed in the future. For example, New York recently adopted an affiliate marketing statute and related regulations that impose sales and use tax collection obligations on out-of-state sellers that use certain web-based affiliate marketing relationships with web-based affiliates deemed to be located in New York. Other states such as California, Connecticut, Hawaii and Minnesota have proposed similar legislation. There can be no assurance that existing or future laws that impose taxes or other regulations on direct marketing or Internet commerce would not substantially impair our growth or otherwise have a material adverse effect on our business, results or operations and financial condition.

 

In addition, we and our subsidiaries may be subject to state or local taxes on income or (in states such as Kentucky, Michigan, Ohio, Texas or Washington) on gross receipts earned in a state even though we and our subsidiaries may have no physical presence in the state. State and local governments may seek to impose such taxes in cases where they believe the taxpayer may have a significant economic presence by reason of significant sales to customers located in the states. The responsibility to pay income and gross receipts taxes has also been the subject of court actions and various legislative efforts. There can be no assurance that these taxes will not be imposed upon us and our subsidiaries.

 

Furthermore, we are subject to general business laws and regulations, as well as laws and regulations specifically governing companies that do business over the Internet. These laws and regulations may cover taxation of eCommerce, user privacy, marketing and promotional practices (including electronic communications with our customers and potential customers), database protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, product safety, the provision of online payment services, copyrights, patents and other intellectual property rights, data security, unauthorized access (including the Computer Fraud and Abuse Act), and the characteristics and quality of products and services. While we have sought to implement processes, programs and systems in an effort to achieve compliance with existing laws and regulations applicable to our business, many of these laws and regulations are unclear and have yet to be interpreted by courts, or may be subject to conflicting interpretations by courts. Further, no assurances can be given that new laws or regulations will not be enacted or adopted, or that our processes, programs and systems will be sufficient to comply with present or future laws or regulations, which might adversely affect our operations.

 

Such existing and future laws and regulations may also impede the growth of the Internet or other online services, including our business. Additionally, it is not always clear how existing laws and regulations governing issues such as property ownership, sales and other taxes, libel, trespass, data mining and collection, data security and personal privacy, among other laws, apply to the Internet and eCommerce. Unfavorable resolution of these issues may expose us to liability and costly changes in our business operations, and could reduce customer demand for our products.

 

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The growth and demand for online commerce has and may continue to result in more stringent consumer protection laws that impose additional compliance burdens on online companies. These consumer protection laws could result in substantial compliance costs and could decrease our profitability. For example, data security laws are becoming more widespread and burdensome in the United States, and increasingly require notification of affected individuals and, in some instances, regulators. Moreover, third parties are engaging in increased cyber-attacks against companies doing business on the Internet, and individuals are increasingly subjected to identity and credit card theft on the Internet. There is a risk that we may fail to prevent such activities and that our customers or others may assert claims against us. In addition, the FTC and state consumer protection authorities have brought a number of enforcement actions against U.S. companies for alleged deficiencies in those companies’ data security practices, and they may continue to bring such actions. Enforcement actions, which may or may not be based upon actual cyber attacks or other breaches in such companies’ data security, present an ongoing risk to us, could result in a loss of users and could damage our reputation. Further, additional regulation of the Internet may lead to a decrease in Internet usage, which could adversely affect our business.

 

Growing public concern about privacy and the collection, distribution and use of information about individuals may subject us to increased regulatory scrutiny or litigation. In the past, the FTC has investigated companies that have used personally identifiable information without permission or in violation of a stated privacy policy. If we are accused of violating the stated terms of our privacy policy, we may face a loss of users and damage to our reputation and be forced to expend significant amounts of financial and managerial resources to defend against these accusations and we may face potential liability as well as extended regulatory oversight in the form of a long-term consent order.

 

Additionally, although historically only a small percentage of our total sales in any given quarter or year are made to customers outside of the continental United States, there is a possibility that a foreign jurisdiction may take the position that our business is subject to its laws and regulations, which could impose restrictions or burdens on us and expose us to tax and other potential liabilities and could also require costly changes to our business operations with respect to those jurisdictions.

 

Part of our business strategy includes the acquisition of other companies, and we may have difficulties integrating acquired companies into our operations in a cost-effective manner, if at all.

 

One element of our business strategy involves expansion through the acquisition of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, or add new business capabilities. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic partnerships, and the purchase or sale of assets. Our acquisition strategy depends on the availability of suitable acquisition candidates at reasonable prices and our ability to resolve challenges associated with integrating acquired businesses into our existing business. No assurance can be given that the benefits or synergies we may expect from the acquisition of companies or businesses will be realized to the extent or in the time frame we anticipate. We may lose key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans. In addition, acquisitions may involve a number of risks and difficulties, including expansion into new geographic markets and business areas, the diversion of management’s attention to the operations and personnel of the acquired company, the integration of the acquired company’s personnel, operations and management information (ERP) systems, changing relationships with customers, suppliers and strategic partners, and potential short-term adverse effects on our operating results. These challenges can be magnified as the size of the acquisition increases. Any delays or unexpected costs incurred in connection with the integration of acquired companies or otherwise related to the acquisitions could have a material adverse effect on our business, financial condition and results of operations.

 

Acquisitions may require large one-time charges and can result in increased debt or other contingent liabilities, adverse tax consequences, deferred compensation charges, the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, and the refinement or revision of fair value acquisition estimates following the completion of acquisitions, any of which items could negatively impact our business, financial condition and results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline.

 

An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, or involve our issuance of additional equity securities. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company. If we incur additional debt to pay for an acquisition, it may significantly reduce amounts that would otherwise be available under our credit facility, increase our interest expense, leverage and debt service requirements and could negatively impact our ability to comply with applicable financial covenants in our credit facility or limit our ability to obtain credit from our vendors. Acquired entities also may be highly leveraged or dilutive to our earnings per share, or may have unknown liabilities. In addition, the combined entity may have lower revenues or higher expenses and therefore may not achieve the anticipated results. Any of these factors relating to acquisitions could have a material adverse impact on our business, financial condition and results of operations.

 

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We cannot assure you that we will be able to consummate any pending or future acquisitions or that we will realize any anticipated benefits from these acquisitions. We may not be able to find suitable acquisition opportunities that are available at attractive valuations, if at all. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions on commercially acceptable terms, and any decline in the price of our common stock may make it significantly more difficult and expensive to initiate or consummate additional acquisitions. We cannot assure you that we will be able to implement or sustain our acquisition strategy or that our strategy will ultimately prove profitable.

 

If goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.

 

The purchase price allocation for our historical acquisitions resulted in a material amount allocated to goodwill and intangible assets. In accordance with GAAP, we review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We review the fair values of our goodwill and intangible assets with indefinite useful lives and test them for impairment annually or whenever events or changes in circumstances indicate an impairment may have occurred. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or intangible assets may not be recoverable include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant non-cash charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill or intangible assets is determined, which could have a material adverse effect on our results of operations.

 

Significant negative industry or economic trends, including decreases in our market capitalization, slower growth rates or lack of growth in our business, resulted in write-downs and impairment charges in fiscal 2008. While no such write-downs or charges occurred in fiscal 2009 or the first six months of 2010, if such occur in the future it may indicate that additional impairment charges are required. If we are required to record additional impairment charges, this could have a material adverse affect on our consolidated financial statements. In addition, the testing of goodwill for impairment requires us to make significant estimates about the future performance and cash flows of our company, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in underlying business operations, future reporting unit operating performance, existing or new product market acceptance, changes in competition, or changes in technologies. Any changes in key assumptions, or actual performance compared with those assumptions, about our business and future prospects or other assumptions could affect the fair value of one or more reporting units, resulting in an impairment charge.

 

We may not be able to maintain profitability on a quarterly or annual basis.

 

Our ability to maintain profitability on a quarterly or annual basis given our planned business strategy depends upon a number of factors, including, but not limited to, our ability to achieve and maintain vendor relationships, procure merchandise and fulfill orders in an efficient manner, leverage our fixed cost structure, maintain adequate levels of vendor consideration and price protection, maintain a well-balanced product and customer mix, maintain customer acquisition costs and shipping costs at acceptable levels, and our ability to effectively compete in the marketplace with our competitors. Our ability to maintain profitability on a quarterly or annual basis will also depend on our ability to manage and control operating expenses and to generate and sustain adequate levels of revenue. Many of our expenses are fixed in the short term, and we may not be able to quickly reduce spending if our revenue is lower than what we project. In addition, we may find that our business plan costs more to execute than what we currently anticipate. Some of the factors that affect our ability to maintain profitability on a quarterly or annual basis are beyond our control, including general economic trends and uncertainties.

 

The effect of accounting rules for stock-based compensation may materially adversely affect our consolidated operating results, our stock price and our ability to hire, retain and motivate employees.

 

We use employee stock options and other stock-based compensation to hire, retain and motivate certain of our employees. Current accounting rules require us to measure compensation costs for all stock-based compensation (including stock options) at fair value as of the date of grant and to recognize these costs as expenses in our consolidated statements of operations. The recognition of non-cash stock-based compensation expenses in our consolidated statements of operations has had and will likely continue to have a negative effect on our consolidated operating results, including our net income and earnings per share, which could negatively impact our stock price. Additionally, if we reduce or alter our use of stock-based compensation to reduce these expenses and their impact, our ability to hire, motivate and retain certain employees could be adversely affected and we may need to increase the cash compensation we pay to these employees.

 

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Our operating results are difficult to predict and may adversely affect our stock price.

 

Our operating results have fluctuated in the past and are likely to vary significantly in the future based upon a number of factors, many of which we cannot control. We operate in a highly dynamic industry and future results could be subject to significant fluctuations. These fluctuations could cause us to fail to meet or exceed financial expectations of investors or analysts, which could cause our stock price to decline rapidly and significantly. Revenue and expenses in future periods may be greater or less than revenue and expenses in the immediately preceding period or in the comparable period of the prior year. Therefore, period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. Some of the factors that could cause our operating results to fluctuate include:

 

·             the amount and timing of operating costs and capital expenditures relating to any expansion of our business operations and infrastructure;

·             price competition that results in lower sales volumes, lower profit margins, or net losses;

·             fluctuations in mail-in rebate redemption rates;

·             the amount and timing of advertising and marketing costs;

·             our ability to successfully integrate operations and technologies from any past or future acquisitions or other business combinations;

·             revisions or refinements of fair value estimates relating to acquisitions or other business combinations;

·             changes in the number of visitors to our websites or our inability to convert those visitors into customers;

·             technical difficulties, including system or Internet failures;

·             fluctuations in the demand for our products or overstocking or under-stocking of our products;

·             introduction of new or enhanced services or products by us or our competitors;

·             fluctuations in shipping costs, particularly during the holiday season;

·             changes in the amounts of information technology spending by SMB, MME, Public Sector and MacMall segment customers;

·             economic conditions;

·             foreign currency exchange rate;

·             changes in the mix of products that we sell; and

·             fluctuations in levels of inventory theft, damage or obsolescence that we incur.

 

If we fail to accurately predict our inventory risk, our gross margins may decline as a result of required inventory write downs due to lower prices obtained from older or obsolete products.

 

We derive a significant amount of our gross sales from products sold out of inventory at our distribution facilities. We assume the inventory damage, theft and obsolescence risks, as well as price erosion risks for products that are sold out of inventory stocked at our distribution facilities. These risks are especially significant because many of the products we sell are characterized by rapid technological change, obsolescence and price erosion (e.g., computer hardware, software and consumer electronics), and because our distribution facilities sometimes stock large quantities of particular types of inventory. There can be no assurance that we will be able to identify and offer products necessary to remain competitive, maintain our gross margins, or avoid or minimize losses related to excess and obsolete inventory. We currently have limited return rights with respect to products we purchase from Apple, HP, Lenovo, and certain other vendors, but these rights vary by product line, are subject to specified conditions and limitations, and can be terminated or changed at any time.

 

We may need additional financing and may not be able to raise additional financing on favorable terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership interests of existing stockholders.

 

We require substantial working capital to fund our business. We believe that our current working capital, including our existing cash balance, together with our expected future cash flows from operations and available borrowing capacity under our existing credit facility, which functions as a working capital line of credit, will be adequate to support our current operating plans for at least the next twelve months. However, if we need additional financing, such as for acquisitions or expansion or to finance our operations during a significant downturn in sales or an increase in operating expenses, there are no assurances that adequate financing will be available on acceptable terms, if at all. We may in the future seek additional financing from public or private debt or equity financings to fund additional expansion, or take advantage of opportunities or favorable market conditions. There can be no assurance such financings will be available on terms favorable to us or at all. To the extent any such financings involve the issuance of equity securities, existing stockholders could suffer dilution. If we raise additional financing through the issuance of equity, equity-related or debt securities, those securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders will experience dilution of their ownership interests. If additional financing is required but not available, we would have to implement further measures to conserve cash and reduce costs. However, there is no assurance that such measures would be successful. Our failure to raise required additional financing could adversely affect our ability to maintain, develop or enhance our product offerings, take advantage of future opportunities, respond to competitive pressures or continue operations.

 

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Our existing credit facility contains terms that are more favorable to us than terms that we believe would otherwise be available to us in the current credit market environment. We have been informed by the administrative agent for the facility that any amendment, modification, waiver, consent or other change we may seek with regard to our facility will result in the renegotiation of the terms of the facility and that any such renegotiated terms would likely include terms less favorable to us, such as the addition of stricter financial covenants and less favorable interest rate terms. Such limitations could adversely affect our ability to pursue certain acquisitions and other strategic transactions which would require an amendment or consent under the existing credit facility. Additionally, if market conditions have not improved by the time our current credit facility expires in 2011, we expect that any new facility, to the extent available to us at such time, would be on terms less favorable to us than our existing credit facility.

 

There has been significant ongoing weakness in the global economic environment, coupled with disruptions in the capital and credit markets. Continued problems in these areas could have a negative impact on our ability to obtain financing if we need additional funds, such as for acquisitions or expansion, to fund a significant downturn in our sales or an increase in our operating expenses, or to take advantage of opportunities or favorable market conditions, in the future. To the extent we seek additional financing from public or private debt or equity issuances, there can be no assurance that such financing will be available at acceptable terms, if at all. There can be no assurance that the cost or availability of future borrowings, if any, under our credit facility or in the debt markets will not be impacted by disruptions or continued weakness in the capital and credit markets.

 

Rising interest rates could negatively impact our results of operations and financial condition.

 

A significant portion of our working capital requirements has historically been funded through borrowings under our credit facility, which functions as a working capital line of credit and bears interest at variable rates, tied to the LIBOR or prime rate. In connection with and as part of the line of credit, we also entered into a term note, bearing interest at the same rate as our credit facility. If the variable interest rates on our line of credit and term note increase, we could incur greater interest expense than we have in the past. Rising interest rates, and our increased interest expense that would result from them, could negatively impact our results of operations and financial condition.

 

We may be subject to claims regarding our intellectual property, including our business processes, or the products we sell, any of which could result in expensive litigation, distract our management or force us to enter into costly royalty or licensing agreements.

 

Third parties have asserted, and may in the future assert, that our business or the technologies we use infringe on their intellectual property rights. As a result, we may be subject to intellectual property legal proceedings and claims in the ordinary course of our business. We cannot predict whether third parties will assert additional claims of infringement against us in the future or whether any future claims will prevent us from offering popular products or operating our business as planned. If we are forced to defend against any third-party infringement claims, whether they are with or without merit or are determined in our favor, we could face expensive and time-consuming litigation, which could result in the imposition of a preliminary injunction preventing us from continuing to operate our business as currently conducted throughout the duration of the litigation or distract our technical and management personnel. If we are found to infringe, we may be required to pay monetary damages, which could include treble damages and attorneys’ fees for any infringement that is found to be willful, and either be enjoined or required to pay ongoing royalties with respect to any technologies found to infringe. Further, as a result of infringement claims either against us or against those who license technology to us, we may be required, or deem it advisable, to develop non-infringing technology, which could be costly and time consuming, or enter into costly royalty or licensing agreements. Such royalty or licensing agreements, if required, may be unavailable on terms that are acceptable to us, or at all. If a third party successfully asserts an infringement claim against us and we are enjoined or required to pay monetary damages or royalties or we are unable to develop suitable non-infringing alternatives or license the infringed or similar technology on reasonable terms on a timely basis, our business, results of operations and financial condition could be materially harmed. Similarly, we may be required incur substantial monetary and diverted resource costs in order to protect our intellectual property rights against infringement by others.

 

Furthermore, we sell products manufactured and distributed by third parties, some of which may be defective. If any product that we sell were to cause physical injury or damage to property, the injured party or parties could bring claims against us as the retailer of the product. Our insurance coverage may not be adequate to cover every claim that could be asserted. If a successful claim were brought against us in excess of our insurance coverage, it could expose us to significant liability. Even unsuccessful claims could result in the expenditure of funds and management time and could decrease our profitability.

 

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Costs and other factors associated with pending or future litigation could materially harm our business, results of operations and financial condition.

 

From time to time we receive claims and become subject to litigation, including consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Additionally, we may from time to time institute legal proceedings against third parties to protect our interests. Any litigation that we become a party to could be costly and time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business and could incur significant costs in asserting, defending, or settling any such litigation. We cannot determine with any certainty the costs or outcome of pending or future litigation. Any such litigation may materially harm our business, results of operations and financial condition.

 

We may fail to expand our product, services and solutions categories and offerings, our websites or our processing systems in a cost-effective and timely manner as may be required to efficiently operate our business.

 

We may be required to expand or change our product, services and solutions categories or offerings, our websites or our processing systems in order to compete in our highly competitive and rapidly changing industry or to efficiently operate our business. Any failure on our part to expand or change the way we do business in a cost-effective and timely manner in response to any such requirements would likely adversely affect our operating results, financial condition and future prospects. Additionally, we cannot assure you that we will be successful in implementing any such changes when and if they are required.

 

We have generated substantial portions of our revenue in the past from the sale of computer hardware, software and accessories and consumer electronics products. Expansion into new product, service and solutions categories may require us to incur significant marketing expenses, develop relationships with new vendors and comply with new regulations. We may lack the necessary expertise in a new category to realize the expected benefits of that new category. These requirements could strain our managerial, financial and operational resources. Additional challenges that may affect our ability to expand into new product, service or solutions categories include our ability to:

 

·             establish or increase awareness of our new brands and product, service and solutions categories;

·             acquire, attract and retain customers at a reasonable cost;

·             achieve and maintain a critical mass of customers and orders across all of our product categories;

·             attract a sufficient number of new customers to whom any new categories and offerings are targeted;

·             successfully market our new categories or offerings to existing customers;

·             maintain or improve our gross margins and fulfillment costs;

·             attract and retain vendors to provide expanded lines of products, services or solutions to our customers on terms that are acceptable to us; and

·             manage our inventory in new product categories.

 

We cannot be certain that we will be able to successfully address any or all of these challenges in a manner that will enable us to expand our business into new product categories in a cost-effective or timely manner. If our new categories of products or services are not received favorably, or if our suppliers fail to meet our customers’ expectations, our results of operations would suffer and our reputation and the value of the applicable new brand and our other brands could be damaged. The lack of market acceptance of our new product categories or our inability to generate satisfactory revenue from any expanded product categories to offset their cost could harm our business.

 

We may not be able to attract and retain key personnel such as senior management and information technology specialists.

 

Our future performance will depend to a significant extent upon the efforts and abilities of certain key management and other personnel, including Frank F. Khulusi, our Chairman of the Board, President and Chief Executive Officer, as well as other executive officers and senior management. The loss of service of one or more of our key management members could have a material adverse effect on our business. Our success and plans for future growth will also depend in part on our management’s continuing ability to hire, train and retain skilled personnel in all areas of our business. For example, our management information systems and processes require the services of employees with extensive knowledge of these systems and processes and the business environment in which we operate, and in order to successfully implement and operate our systems and processes we must be able to attract and retain a significant number of information technology specialists. We may not be able to attract, train and retain the skilled personnel required to, among other things, implement, maintain, and operate our information systems and processes, and any failure to do so would likely have a material adverse effect on our operations.

 

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If we fail to achieve and maintain adequate internal controls, we may not be able to produce reliable financial reports in a timely manner or prevent financial fraud.

 

We monitor and periodically test our internal control procedures. We may from time to time identify deficiencies which we may not be able to remediate in a timely or cost-effective manner. In addition, if we fail to achieve and maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting. Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important in helping prevent financial fraud. If we cannot provide reliable financial reports on a timely basis or prevent financial fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock could drop significantly.

 

Any inability to effectively manage our growth may prevent us from successfully expanding our business.

 

The growth of our business has required us to make significant additions in personnel and has significantly increased our working capital requirements. Although we have experienced significant sales growth in the past, such growth should not be considered indicative of future sales growth. Such growth has resulted in new and increased responsibilities for our management personnel and has placed and continues to place significant strain upon our management, operating and financial systems, and other resources. Any future growth, whether organic or through acquisition, may result in increased strain. There can be no assurance that current or future strain will not have a material adverse effect on our business, financial condition, and results of operations, nor can there be any assurance that we will be able to attract or retain sufficient personnel to continue the expansion of our operations. Also crucial to our success in managing our growth will be our ability to achieve additional economies of scale. We cannot assure you that we will be able to achieve such economies of scale, and the failure to do so could have a material adverse effect upon our business, financial condition and results of operations.

 

Our advertising and marketing efforts may be costly and may not achieve desired results.

 

We incur substantial expense in connection with our advertising and marketing efforts. Postage represents a significant expense for us because we generally mail our catalogs to current and potential customers through the U.S. Postal Service. Any future increases in postal rates will increase our mailing expenses and could have a material adverse effect on our business, financial condition and results of operations. We also incur significant expenses related to purchasing the paper we use in printing our catalogs. The cost of paper has fluctuated over the last several years, and may increase in the future. We believe that we may be able to recoup a portion of any increased postage and paper costs through increases in vendor advertising rates, but no assurance can be given that any efforts we may undertake to offset all or a portion of future increases in postage, paper and other advertising and marketing costs through increases in vendor advertising rates will be successful or sustained, or that they will offset all of the increased costs. Furthermore, although we target our advertising and marketing efforts on current and potential customers who we believe are likely to be in the market for the products we sell, we cannot assure you that our advertising and marketing efforts will achieve our desired results. In addition, we periodically adjust our advertising expenditures in an effort to optimize the return on such expenditures. Any decrease in the level of our advertising expenditures which may be made to optimize such return could adversely affect our sales.

 

We are exposed to the credit risk of some of our customers and to credit exposures in weakened markets, which could negatively impact our business, operating results and financial condition.

 

Business customers who qualify are provided credit terms and while we monitor individual customer payment capability and maintain reserves we believe are adequate to cover exposure for doubtful accounts, we have exposure to credit risk in the event that customers fail to meet their payment obligations. Additionally, to the degree that the ongoing tightness in the credit markets makes it more difficult for some customers to obtain financing, those customers’ ability to meet their payment obligations to us could be adversely impacted, which in turn could have a material adverse impact on our business, operating results, and financial condition.

 

Increased product returns or a failure to accurately predict product returns could decrease our revenue and impact profitability.

 

We make allowances for product returns in our consolidated financial statements based on historical return rates. We are responsible for returns of certain products ordered through our catalogs and websites from our distribution center, as well as

 

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