Pcm 10Q 2006 Q3 Quarterly report

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 September 30, 2006

¨	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

incorporation or organization)

(I.R.S. Employer

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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

As of November 2, 2006, the registrant had 12,224,495 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 September 30, 2006 and December 31, 2005		2

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and September 30, 2005		3

Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2006		4

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and September 30, 2005		5

Notes to the Consolidated Financial Statements		6

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations		18

Item 3.Quantitative and Qualitative Disclosures About Market Risk		31

Item 4.Controls and Procedures		31

PART II - OTHER INFORMATION (unaudited)

Item 1.Legal Proceedings		33

Item 1A.Risk Factors		33

Item 4.Submission of Matters to a Vote of Security Holders		45

Item 6.Exhibits		45

Signature		46

PC MALL, INC.

PART I - FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

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


	September 30, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	6,872		$	6,289
Accounts receivable, net of allowances of $4,818 and $4,774		116,718			102,981
Inventories, net		39,998			64,448
Prepaid expenses and other current assets		9,084			8,330
Deferred income taxes		3,597			3,597

Total current assets		176,269			185,645
Property and equipment, net		8,454			8,416
Deferred income taxes		7,338			8,821
Goodwill		3,473			1,405
Intangible assets, net		1,319			449
Other assets		491			506

Total assets	$	197,344		$	205,242

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	79,556		$	64,728
Accrued expenses and other current liabilities		20,680			20,839
Deferred revenue		12,914			10,440
Line of credit		23,785			53,517
Note payable – current		500			500

Total current liabilities		137,435			150,024
Note payable		1,875			2,250

Total liabilities		139,310			152,274

Commitments and contingencies (Note 12)
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; 12,518,695 and 12,015,641 shares issued; and 12,224,495 and 11,721,441 shares outstanding, respectively		13			12
Additional paid-in capital		86,062			83,533
Treasury stock, at cost: 294,200 shares		(1,015	)		(1,015	)
Accumulated other comprehensive income		562			274
Accumulated deficit		(27,588	)		(29,836	)

Total stockholders’ equity		58,034			52,968

Total liabilities and stockholders’ equity	$	197,344		$	205,242

See Notes to the Consolidated Financial Statements.

PC MALL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Net sales	$	242,171	$	244,039	$	710,512	$	735,583
Cost of goods sold		210,615		214,546		620,533		650,739

Gross profit		31,556		29,493		89,979		84,844
Selling, general and administrative expenses		27,480		28,169		83,339		87,897

Operating profit (loss)		4,076		1,324		6,640		(3,053	)
Interest expense, net		912		739		2,912		2,067

Income (loss) from continuing operations before income taxes		3,164		585		3,728		(5,120	)
Income tax expense (benefit)		1,256		356		1,480		(1,811	)

Income (loss) from continuing operations		1,908		229		2,248		(3,309	)
Loss from discontinued operation, net of taxes		—		—		—		(1,781	)

Net income (loss)	$	1,908	$	229	$	2,248	$	(5,090	)

Basic and Diluted Earnings (Loss) Per Common Share
Basic earnings (loss) per share:
Income (loss) from continuing operations	$	0.16	$	0.02	$	0.19	$	(0.29	)
Loss from discontinued operation, net of taxes		—		—		—		(0.15	)

Net income (loss)	$	0.16	$	0.02	$	0.19	$	(0.44	)

Diluted earnings (loss) per share:
Income (loss) from continuing operations	$	0.15	$	0.02	$	0.18	$	(0.29	)
Loss from discontinued operation, net of taxes		—		—		—		(0.15	)

Net income (loss)	$	0.15	$	0.02	$	0.18	$	(0.44	)

Weighted average number of common shares outstanding:
Basic		12,214		11,702		11,978		11,630
Diluted		12,927		12,403		12,842		11,630

See Notes to the Consolidated Financial Statements.

PC MALL, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(unaudited, in thousands)


	Common Stock			Additional Paid-in- Capital		Treasury Stock			Accumulated Other Comprehensive Income		Accumulated Deficit			Total
	Outstanding	Amount		Additional Paid-in- Capital		Treasury Stock			Accumulated Other Comprehensive Income		Accumulated Deficit			Total
Balance at December 31, 2005	11,721	$	12	$	83,533	$	(1,015	)	$	274	$	(29,836	)	$	52,968
Stock option exercises	503		1		544		—			—					545
Stock-based compensation expense	—		—		1,171		—			—		—			1,171
Vested stock option and warrant issued to non-employees	—		—		814		—			—		—			814

Subtotal	—		—		—		—			—		—			55,498

Net income	—		—		—		—			—		2,248			2,248
Translation adjustments	—		—		—		—			288		—			288

Comprehensive income	—		—		—		—			—		—			2,536

Balance at September 30, 2006	12,224	$	13	$	86,062	$	(1,015	)	$	562	$	(27,588	)	$	58,034

See Notes to the Consolidated Financial Statements.

PC MALL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)


	Nine Months Ended September 30,
	2006			2005
				(Revised)
Cash Flows From Operating Activities
Net income (loss)	$	2,248		$	(5,090	)
Loss from discontinued operations, net of taxes		—			1,781

Income (loss) from continuing operations		2,248			(3,309	)
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities:
Depreciation and amortization		3,071			3,032
Provision (benefit) for deferred income taxes		1,480			(2,113	)
Tax benefit related to stock option exercises		—			302
Non-cash stock-based compensation		1,171			85
Gain on sale of fixed assets		—			(26	)
Change in operating assets and liabilities:
Accounts receivable		(13,737	)		(4,798	)
Inventories		24,450			27,541
Prepaid expenses and other current assets		(754	)		(2,059	)
Other assets		14			(128	)
Accounts payable		12,169			(1,858	)
Accrued expenses and other current liabilities		655			(2,009	)
Deferred revenue		2,474			(288	)

Total adjustments		30,993			17,681

Net cash provided by operating activities		33,241			14,372

Cash Flows From Investing Activities
Purchases of property and equipment		(2,687	)		(2,547	)
Acquisition of GMRI’s products business		(3,359	)		—
Proceeds from sale of property and equipment		—			93

Net cash used in investing activities		(6,046	)		(2,454	)

Cash Flows From Financing Activities
Repayments under note payable		(375	)		(375	)
Net payments under line of credit		(29,732	)		(11,852	)
Change in book overdraft		2,659			(935	)
Proceeds from stock issued under stock option plans		545			324

Net cash used in financing activities		(26,903	)		(12,838	)

Effect of foreign currency on cash flow		291			132

Net cash provided by (used in) continuing operations		583			(788	)
Cash Flows From Discontinued Operation (Revised – See Note 1)
Net cash flow from operating activities		—			(5,937	)
Net cash flow from investing activities		—			5,937
Net cash flow from financing activities		—			—

Net cash flows from discontinued operation		—			—

Net increase (decrease) in cash and cash equivalents		583			(788	)
Cash and cash equivalents at beginning of the period		6,289			6,473

Cash and cash equivalents at end of the period	$	6,872		$	5,685

Supplemental Cash Flow Information
Interest paid	$	2,472		$	2,068
Income taxes paid		99			135

See Notes to the Consolidated Financial Statements.

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 “we” or “us”), founded in 1987, is a rapid response direct marketer of computer hardware, software, peripherals, electronics, and other consumer products and services. We offer products and services to businesses, government and educational institutions, as well as individual consumers, through dedicated outbound and inbound telemarketing account executives, the Internet, direct marketing techniques, direct response catalogs, a direct sales force and three retail showrooms. We offer a broad selection of products through our distinctive full-color catalogs under the PC Mall, MacMall and PC Mall Gov brands, our websites pcmall.com, macmall.com, pcmallgov.com, wareforce.com and onsale.com, and other promotional materials.

On April 11, 2005, we completed the spin-off of our 80.2% owned subsidiary, eCOST.com, Inc. (“eCOST.com”) when we distributed approximately 1.2071 shares of eCOST.com common stock as a special dividend on each outstanding share of our common stock to our stockholders of record on March 28, 2005. As a result of the spin-off, eCOST.com, which was a segment of our company, is presented as a discontinued operation for the prior periods presented herein. Our remaining reportable segments are Core business and OnSale.com, which are more fully discussed in Note 10. See Note 3 below for more information on the discontinued operation of eCOST.com.

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. 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 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, 2005 filed with the SEC on March 31, 2006 and amended on May 1, 2006, our Quarterly Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006 filed with the SEC on May 11, 2006 and August 8, 2006, and all of our other periodic filings, including Current Reports on Form 8-K, filed with the SEC.

Reclassifications

Certain prior period balances have been reclassified to conform to the current period presentation.

Revised Presentation of Consolidated Statements of Cash Flows

Beginning in the fourth quarter of 2005, we have revised the presentation of our Consolidated Statements of Cash Flows for all periods presented to separately disclose the operating, investing and financing portions of the cash flows attributable to the discontinued operation of eCOST.com, which we spun-off in April 2005. We had previously reported these amounts on a combined basis in our quarterly financial statements in 2005.

2.	Summary of Significant Accounting Policies

Stock-Based Compensation

On January 1, 2006, we adopted the provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the modified prospective transition method. SFAS 123R 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. SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), as we formerly did, and 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 SFAS 123R apply to new stock option grants subsequent to December 31, 2005 and unvested stock options outstanding as of January 1, 2006.

The modified prospective application method requires that compensation expense be recorded for all unvested stock options outstanding at the beginning of the first quarter of adopting SFAS 123R, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”) and for new share-based payment awards granted subsequent to our adoption of SFAS 123R, based on the grant date fair value estimated in accordance with SFAS 123R, both adjusted for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant, and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Under the modified prospective application method, our prior period financial statements were not restated to retrospectively apply SFAS 123R. In addition, under SFAS 123R, we elected to use the Black-Scholes option pricing model to value options we grant, which is consistent with our valuation model previously used for options in pro forma footnote disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by SFAS 148. See Note 4 for a further discussion of the impact of the adoption of SFAS 123R.

Prior to adopting SFAS 123R, we accounted for share-based compensation awards using the intrinsic value method as prescribed by APB 25. As required by SFAS 148, the following table presents the effect on “Income (loss) from continuing operations” of recognizing stock-based compensation cost as if the fair value based method had been applied to all outstanding and unvested stock options as of the period presented (in thousands, except per share amounts):


	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Income (loss) from continuing operations (as reported)	$	229		$	(3,309	)
Less stock compensation expense, net of taxes, determined under the fair value based method		(325	)		(1,463	)
Add stock compensation expense, net of taxes, included in reported loss from continuing operations		—			—

Loss from continuing operations (pro forma)	$	(96	)	$	(4,772	)

Basic and diluted earnings (loss) from continuing operations per common share:
Basic – as reported	$	0.02		$	(0.29	)
Basic – pro forma		(0.01	)		(0.41	)
Diluted – as reported	$	0.02		$	(0.29	)
Diluted – pro forma		(0.01	)		(0.41	)

The following table presents the effect on “Net income (loss)” of recognizing stock-based compensation cost as if the fair value based method had been applied to all outstanding and unvested stock options as of the periods presented (in thousands, except per share amounts):


	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Net income (loss) (as reported)	$	229		$	(5,090	)
Less stock compensation expense, net of taxes, determined under the fair value based method		(325	)		(1,768	)
Add stock compensation expense, net of taxes, included in reported net loss		—			93

Net loss (pro forma)	$	(96	)	$	(6,765	)

Basic and diluted earnings (loss) per common share:
Basic – as reported	$	0.02		$	(0.44	)
Basic – pro forma		(0.01	)		(0.58	)
Diluted – as reported	$	0.02		$	(0.44	)
Diluted – pro forma		(0.01	)		(0.58	)

The fair value of each stock option grant, presented above in the pro forma stock compensation expense, has been estimated pursuant to SFAS 123 on the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used:


	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Risk free interest rate		4.05	%		3.84	%
Expected volatility		70	%		102	%
Expected term		6 years			5 years
Expected dividend yield		None			None
Weighted average grant-date fair value	$	3.24		$	4.09

Stock Option Issued to Executive Officers and Non-employee Directors

In late June 2005, the board of directors approved and we issued stock options under our Amended and Restated 1994 Stock Incentive Plan (“1994 Plan”) to our executive officers and non-employee directors to purchase a total of 225,000 shares of our common stock. The options, which were issued at an exercise price equal to the fair value at the date of grant, have a ten-year term and vest quarterly over a three-year period from the date of grant for the executive officers, and vest quarterly over a two-year period for our non-employee directors.

Stock Option Issued to Non-employee

In October 2004, we issued options to purchase 45,000 shares of our common stock under our 1994 Plan to an investor and public relations consultant. The options were issued at an exercise price of $15.43 with a five-year term. Effective April 11, 2005, as a result of the spin-off of eCOST.com, the exercise price of the options was reduced to $6.12 and the consultant received options to purchase 54,319 shares of eCOST.com common stock in the transaction. Of the original grant of options to purchase 45,000 shares, an aggregate of 7,500 shares of the options vested on the date of the grant, and the remaining shares vested quarterly over a one-year period from the date of grant. We valued the options at fair value based on a Black-Scholes fair value calculation. The options were valued at the date of grant and were measured at fair value at each subsequent reporting period, with changes in value recorded over the twelve month performance period of the option. The options became fully vested in October 2005. We recorded a cumulative compensation expense of $0.4 million, of which less than $0.1 million related to the three and nine months ended September 30, 2005. The options were still outstanding at September 30, 2006.

Other Recent Accounting Pronouncements

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), which establishes a dual approach that requires the quantification of financial statement errors on a single quantification framework to be used by all public companies. Under SAB 108, financial statement errors will be quantified based on the effects of the error on each of a company’s financial statements and the related disclosures. This dual approach requires that errors be quantified under both the iron-curtain method, which focuses primarily on the effect of correcting the period-end balance sheet, and the roll-over method, which focuses primarily on the impact of an error on the income statement. SAB 108 is effective for fiscal years ending after November 15, 2006. We believe that the adoption of SAB 108 will not have a significant impact on our consolidated results of operations or financial position.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”), which clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We believe that the adoption of SFAS 157 will not have a significant impact on our consolidated results of operations or financial position.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. Only tax positions that meet the more-likely-than-not recognition threshold

at the effective date may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year. We believe that the adoption of FIN 48 will not have a significant impact on our consolidated results of operations or financial position.

In June 2006, the FASB ratified EITF Issue No. 06-03, “How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)” (“EITF 06-03”). EITF 06-03 provides that any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer may include, but is not limited to, sales, use, value added, and some excise taxes. EITF 06-03 also provides that the presentation of such taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that a company should make and disclose in its financial statements, and disclose any such taxes that are reported on a gross basis, if material, for each period for which an income statement is presented. EITF 06-03 is effective for financial statements for interim and annual reporting periods beginning after December 15, 2006. We believe that the adoption of EITF 06-03 will not have a significant impact on our consolidated results of operations or financial position.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”). SFAS 154 replaces Accounting Principles Board Opinion No. 20, “Accounting Changes” (“APB 20”) and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. Under APB 20, a change in accounting principle was recognized as a cumulative effect of accounting change in the income statement of the period of the change. SFAS 154 generally requires retrospective application to prior periods’ financial statements of voluntary changes in accounting principles. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We adopted SFAS 154 on January 1, 2006. The adoption of SFAS 154 did not have a significant impact on our consolidated results of operations or financial position.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing” (“ARB 43”) to clarify the accounting for abnormal amounts of idle facility expense, double freight, rehandling costs and wasted material. SFAS 151 requires that these types of costs be recognized as current period expenses regardless of whether they meet the criteria of “so abnormal” as previously provided in ARB 43. In addition, SFAS 151 requires that allocation of fixed production overhead to the costs of conversion be based on normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We adopted SFAS 151 on January 1, 2006. The adoption of SFAS 151 did not have a significant impact on our consolidated results of operations or financial position.

3.	Discontinued Operation

On April 11, 2005, we completed the spin-off of eCOST.com, Inc. by distributing our 80.2% ownership interest in eCOST.com to our stockholders. We distributed approximately 1.2071 shares of eCOST.com common stock as a special dividend on each outstanding share of our common stock to our stockholders of record on March 28, 2005. As a result, we distributed to our stockholders an aggregate of 14,000,000 shares of eCOST.com common stock, which had an aggregate market value of approximately $90.3 million based on the last sale price for eCOST.com common stock on the Nasdaq National Market on April 11, 2005.

The financial results of eCOST.com, which were historically reported as an operating segment, have been excluded from our results from continuing operations for all prior periods and have been presented as a discontinued operation. eCOST.com’s revenues, and operating and non-operating results for the nine months ended September 30, 2005 are reflected in a single line item entitled “Loss from discontinued operation, net of taxes” on our Consolidated Statements of Operations as follows (in thousands):


	Nine Months Ended September 30, 2005
Net sales	$	59,781

Loss before income taxes	$	(3,252	)
Income tax benefit		(1,005	)
Minority interest		466

Loss from discontinued operation, net of taxes	$	(1,781	)

4.	Stock-Based Compensation

Stock-Based Benefit Plans

1994 Stock Incentive Plan

In November 1994, our Board of Directors and stockholders approved the 1994 Stock Incentive Plan (the “1994 Plan”), as amended in May 2000 and June 2002 and approved by our Board of Directors and stockholders, which provides for the grant of equity awards such as stock options, restricted stock or restricted stock units to our employees, officers, directors and consultants. Under the 1994 Plan, we may grant options (“Incentive Stock Options”) within the meaning of Section 422A of the Internal Revenue Code, or options not intended to qualify as Incentive Stock Options (“Nonstatutory Stock Options”). All options generally vest over three to five years, expire ten years from the grant date, are granted at exercise prices equal to the market price of our stock at grant date and are nontransferable other than by will or by the laws of descent and distribution. As of September 30, 2006, a total of 1,490,087 shares of authorized and unissued shares were available for future grants. All options granted through September 30, 2006 have been Nonstatutory Stock Options. We satisfy stock option exercises with newly issued shares.

For more information on our 1994 Plan, refer to Note 10 of the Notes to the Consolidated Financial Statements included in Item 8, Part II of our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on March 31, 2006.

1995 Director Stock Option Plan

We adopted the Directors’ Non-Qualified Stock Option Plan (the “Director Plan”) in 1995. However, in May 2000, our Board of Directors and stockholders voted to terminate the Director Plan such that no further grants would be made thereunder, and further provided that non-employee directors are persons eligible to receive future options and other stock-based awards under the 1994 Plan, as discussed above. As of September 30, 2006, there were 5,000 options outstanding under the Director Plan.

Impact of the Adoption of SFAS 123R

On January 1, 2006, we adopted SFAS 123R using the modified prospective application method. SFAS 123R requires that we measure compensation cost for all unvested stock-based payment awards outstanding as of December 31, 2005 and new stock-based payment awards granted to employees and non-employee directors subsequent to the adoption of SFAS 123R based on estimated fair values as determined on their grant dates, adjusted for estimated forfeitures, and recognize compensation expense over the requisite service period (the vesting period). For the three and nine months ended September 30, 2006, we recognized stock-based compensation expense of $0.4 million and $1.2 million in “Selling, general and administrative expenses” in our Consolidated Statements of Operations, using the straight-line attribution method, and a related deferred income tax benefit of $0.1 million and $0.5 million. Results for prior periods have not been restated pursuant to the modified prospective application method of SFAS 123R.

Prior to our adoption of SFAS 123R on January 1, 2006, we accounted for options granted to employees using the intrinsic value method under APB 25, as allowed under SFAS 123. See Note 2 for the pro forma disclosure of our results of operations and loss per share as if the fair value based method had been applied to the periods prior to our adoption of SFAS 123R and the respective weighted average assumptions used in those periods.

Valuation Assumptions

We estimated the grant date fair value of each stock option grant awarded during the nine months ended September 30, 2006 pursuant to SFAS 123R using the Black-Scholes option pricing model and management assumptions made regarding various factors which require extensive use of accounting judgment and financial estimates. In estimating our assumption regarding the expected term for options granted during the nine months ended September 30, 2006, we applied the simplified method set out in SEC Staff Accounting Bulletin No. 107, “Share-Based Payment,” which was issued in March 2005. We computed 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, which we determined to be six years. The risk free interest rate was determined using the implied yield on U.S. Treasury issues with a remaining term within the contractual life of the award. In the first quarter of 2006, we estimated 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.

The following table presents the weighted average assumptions we used for the current period:


	Three Months Ended September 30, 2006	Nine Months Ended September 30, 2006
Risk free interest rate	—	4.75	%
Expected volatility	—	95	%
Expected term	—	6 years
Expected dividend yield	—	None

No stock options were awarded during the three months ended September 30, 2006.

Stock-Based Payment Award Activity

The following table summarizes our stock option activity during the nine months ended September 30, 2006, and stock options outstanding and exercisable at September 30, 2006 for the above plans:


	Number		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2005	2,627,608		$	3.27
Granted	46,000			5.98
Exercised	(503,054	)		1.08
Forfeited	(75,160	)		5.01
Expired/cancelled	(13,143	)		3.05

Outstanding at September 30, 2006	2,082,251		$	3.79	6.69	$	7,118

Exercisable at September 30, 2006	1,475,225		$	3.23	6.02	$	5,853

The aggregate intrinsic value is calculated based on the difference between the exercise price of the underlying awards and the closing price of our common stock on September 30, 2006, which was $7.19.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Weighted average grant-date fair value of options granted during the period	$	—	$	3.24	$	4.70	$	4.09
Total intrinsic value of options exercised during the period (in thousands)		77		121		2,620		782
Total fair value of shares vested during the period (in thousands)		375		852		1,127		2,316

As of September 30, 2006, there was $1.7 million of unrecognized compensation cost related to unvested outstanding stock options. We expect to recognize this cost over a weighted average period of 1.9 years.

5.	Acquisition

On September 7, 2006, PC Mall Gov, Inc. (“PC Mall Gov”), our wholly-owned subsidiary, acquired the products business from Government Micro Resources, Inc. (“GMRI”) for approximately $3.4 million in cash, including transaction costs. The business includes assets of GMRI’s former products business, which include the GMRI trade names, contracts and the related employees, among other items. We are currently reviewing whether certain contingent liabilities existed at the time of the acquisition. We estimate that such contingent liabilities, if any, could result in an increase to the purchase price by approximately $0.1 million to $0.8 million and could increase the amount allocated to goodwill.

Based on a preliminary purchase price allocation, which is subject to further review, we recorded $2.1 million of goodwill at the Core business segment and $1.3 million of intangible assets and furniture and equipment based on estimated fair values at the date of acquisition as follows (in thousands):


	As of September 7, 2006
Goodwill	$	2,068

Intangible assets:
Product backlog		582
Maintenance contracts		167
Tradenames		240
Software licenses		218
Non-compete agreements		20

Total intangible assets		1,227

Furniture and equipment		64

Total assets acquired	$	3,359

We recorded approximately $0.2 million of amortization expense during the three months ended September 30, 2006 related to the estimated $1.3 million of intangible assets and furniture and equipment acquired in the GMRI transaction. For additional information on intangible assets and goodwill, see Note 6.

Beginning with September 8, 2006, the results of the acquired products business of GMRI have been included in our Core business segment results.

6.	Goodwill and Intangible Assets

Goodwill

As of September 30, 2006 and December 31, 2005, the carrying amounts for goodwill, recorded at the Core business segment, were $3.5 million and $1.4 million.

Intangible Assets

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


	Weighted Average Estimated Useful Lives (years)	September 30, 2006						December 31, 2005
	Weighted Average Estimated Useful Lives (years)	Gross Amount		Accumulated Amortization		Net Amount		Gross Amount		Accumulated Amortization		Net Amount
Patent, trademark & URLs	7	$	922	$	485	$	437	$	682	$	453	$	229
Customer relationship	5		555		472		83		555		388		167
Product backlog	Various(1)		582		180		402		—		—		—
Software licenses	3		218		6		212		—		—		—
Maintenance contracts	Various(1)		167		38		129		—		—		—
Non-compete agreements	5		118		74		44		98		61		37
Other	5		35		23		12		35		19		16

Total intangible assets		$	2,597	$	1,278	$	1,319	$	1,370	$	921	$	449

(1)	Amortization of these intangible assets, which relate to customer orders, are based on actual shipments of goods or performance of service.

Amortization expense for intangible assets was $0.3 million and $0.4 million for the three month and nine month periods ended September 30, 2006 and $0.1 million and $0.2 million for the three month and nine month periods ended September 30, 2005.

Estimated amortization expense for intangible assets, excluding intangible assets based on customer orders, in each of the next five years and thereafter is as follows: $0.1 million in the remainder of 2006; $0.2 million in 2007; $0.2 million in 2008; $0.1 million in 2009; $0.1 million in 2010; and $0.1 million thereafter.

7.	Line of Credit

We maintain a $100 million asset-based revolving credit facility from a lending unit of a large commercial bank, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables. The credit facility has a maturity date of March 2008, bears interest at the prime rate or an option to select the London Interbank Offered Rate (“LIBOR”) plus a spread of 2.0% or 2.50%, depending on certain earning targets, and also includes a commitment fee of 0.25% annually on the unused portion of the line up to $60 million, unless the outstanding borrowings under the credit facility exceed $75 million, at which time the unused line fees will be assessed on the unused portion of the facility up to $80 million. At September 30, 2006, our effective weighted average interest rate was 7.90% and we had $23.8 million of net working capital advances outstanding under the line of credit. At September 30, 2006, we had $27.9 million available to borrow for working capital advances under the line of credit.

In connection with and as a part of the line of credit, we entered into a term note, bearing interest at the prime rate with a LIBOR option, payable in equal monthly installments and maturing in September 2011. As of September 30, 2006, we had $2.375 million outstanding under the term note, payable as follows: $125,000 in the remainder of 2006; $500,000 annually in each of the years 2007 through 2010 and $250,000 thereafter.

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

8.	Earnings (Loss) Per Share

Basic earnings (loss) per share (“EPS”) excludes dilution and is computed by dividing net income (loss) 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.

Potential common shares of approximately 576,000 and 665,000 for the three months ended September 30, 2006 and 2005 and approximately 1,080,000 and 1,258,000 for the nine months ended September 30, 2006 and 2005 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 (Loss)			Shares	Per Share Amounts
Three Months Ended September 30, 2006:
Basic EPS
Income from continuing operations	$	1,908		12,214	$	0.16

Effect of dilutive securities
Dilutive effect of stock options and warrants		—		713

Diluted EPS
Adjusted income from continuing operations	$	1,908		12,927	$	0.15

Three Months Ended September 30, 2005:
Basic EPS
Income from continuing operations	$	229		11,702	$	0.02

Effect of dilutive securities
Dilutive effect of stock options and warrants		—		701

Diluted EPS
Adjusted income from continuing operations	$	229		12,403	$	0.02

Nine Months Ended September 30, 2006:
Basic EPS
Income from continuing operations	$	2,248		11,978	$	0.19

Effect of dilutive securities
Dilutive effect of stock options and warrants		—		864

Diluted EPS
Adjusted income from continuing operations	$	2,248		12,842	$	0.18

Nine Months Ended September 30, 2005:
Basic EPS
Loss from continuing operations	$	(3,309	)	11,630	$	(0.29	)

Effect of dilutive securities
Dilutive effect of stock options and warrants		—		—

Diluted EPS
Adjusted loss from continuing operations	$	(3,309	)	11,630	$	(0.29	)

9.	Comprehensive Income (Loss)

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Net income (loss)	$	1,908	$	229	$	2,248	$	(5,090	)
Other comprehensive income:
Foreign currency translation adjustments		54		271		288		132

Total comprehensive income (loss)	$	1,962	$	500	$	2,536	$	(4,958	)

10.

Segment Information

We operate in two reportable segments: (1) a rapid response supplier of technology solutions for businesses, government and educational institutions, as well as consumers, collectively referred to as “Core business” and (2) an online retailer of computer and consumer electronic products under the OnSale.com brand. We allocate our resources to and evaluate the performance of our segments based on operating income. Corporate expenses are included in our measure of segment operating income for management reporting purposes.

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


Three Months Ended September 30, 2006	Core business			OnSale.com			Consolidated
Net sales	$	239,889		$	2,282		$	242,171
Gross profit		31,183			373			31,556
Operating profit (loss)		4,350			(274	)		4,076

Three Months Ended September 30, 2005
Net sales	$	242,928		$	1,111		$	244,039
Gross profit		29,370			123			29,493
Operating profit (loss)		1,869			(545	)		1,324

Nine Months Ended September 30, 2006
Net sales	$	700,396		$	10,116		$	710,512
Gross profit		88,670			1,309			89,979
Operating profit (loss)		7,754			(1,114	)		6,640

Nine Months Ended September 30, 2005
Net sales	$	732,282		$	3,301		$	735,583
Gross profit		84,610			234			84,844
Operating loss		(1,391	)		(1,662	)		(3,053	)

As of September 30, 2006 and December 31, 2005, we had total consolidated assets of $197.3 million and $205.2 million. Our management does not have available to them and does not use assets measured at the segment level in allocating resources. Therefore, such information relating to segment assets is not provided herein.

11.

Related-Party Transactions

Frank F. Khulusi, our President, Chief Executive Officer and Chairman of the Board of Directors, became a greater than 10% stockholder of eCOST.com in April 2005 as a result of the spin-off of eCOST.com to our stockholders. As a result of his direct and indirect beneficial interests in eCOST.com and us, eCOST.com became our related party. In February 2006, Mr. Khulusi became a less than 10% shareholder of eCOST.com.

In April and May 2005, subsequent to the completion of the spin-off of eCOST.com and in connection with its transition from us, our wholly-owned subsidiary, AF Services, LLC (formerly AF Services, Inc.) (“AF Services”), entered into a product sales agreement and a consignment and product sales agreement with eCOST.com, providing for the sale by AF Services of inventory items to eCOST.com generally at AF Services’ cost. The consignment and product sales agreement terminated in August 2005 and the product sales agreement, which was extended for an additional month, terminated in September 2005. As of September 30, 2006, we had a net receivable of $0.2 million from eCOST.com included in our “Accounts receivable, net” in our Consolidated Balance Sheets.

We are also a party to certain other agreements with eCOST.com that were entered into in conjunction with eCOST.com’s IPO, as follows:

Master Separation and Distribution Agreement

The Master Separation and Distribution Agreement contains the key provisions relating to the separation of the eCOST.com business from our other businesses, the general terms and conditions and corporate transactions required to effect eCOST.com’s IPO and the distribution and the general intent of the parties as to how these matters would be undertaken and completed. The Master Separation and Distribution Agreement may be terminated by the mutual consent of eCOST.com and us.

Tax Allocation and Indemnification Agreement

The Tax Allocation and Indemnification Agreement governs the respective rights, responsibilities and obligations of us and eCOST.com after eCOST.com’s IPO with respect to tax liabilities and benefits, tax attributes, tax contests and other matters regarding income taxes, non-income taxes and related tax returns.

Administrative Services Agreement

Under the Administrative Services Agreement with eCOST.com, as amended in March 2005 to reduce the scope of the services covered by the agreement and the monthly service charge to $19,000, we provided eCOST.com with certain general and administrative services, including but not limited to, the following:

•

payroll administration;

•

tax return preparation;

•

human resources administration;

•

product information management;

•

catalog advertising production services; and

•

accounting and finance services necessary for the preparation of eCOST.com financial statement for the periods through the date of the distribution.

The Administrative Services Agreement terminated on September 1, 2005 in accordance with the terms of the agreement.

Information Technology Systems Usage and Services Agreement

Under the Information Technology Systems Usage and Services Agreement,we provided eCOST.com with usage of telecommunications systems and hardware and software systems, information technology services and related support services, including maintaining eCOST.com’s management information and reporting systems and hosting its website. As consideration for the services and the usage of the hardware and software systems, eCOST.com paid us a monthly fee of $40,000 and provided reimbursement for actual telecommunications systems usage charges. The agreement has a term of two years from eCOST.com’s IPO, but either party may terminate the agreement earlier by providing the other party 180 days prior written notice of such termination. On March 1, 2006, eCOST.com notified us that it has elected to terminate this agreement effective June 30, 2006 in accordance with its termination rights under the agreement. Accordingly, this agreement terminated on June 30, 2006.

Sublease Agreement

Under the Sublease Agreement, eCOST.com leased office space from us located at our corporate headquarters in Torrance, California. In January 2006, pursuant to the terms of the sublease agreement, the monthly base rent increased from $9,130 per month relating to 11,000 square feet to $11,869 per month relating to 14,300 square feet. The sublease terminates in September 2007 pursuant to its terms; however, on March 1, 2006, eCOST.com notified us that it has elected to terminate this agreement effective May 31, 2006 in accordance with its termination rights under the agreement. Accordingly, this sublease terminated on May 31, 2006.

Employee Benefit Matters Agreement

We entered into an Employee Benefit Matters Agreement with eCOST.com which allocates to it some of the assets, liabilities and responsibilities relating to its current and former employees. The agreement provides for eCOST.com’s employees’ continued participation in some of the benefit plans that we sponsor, at eCOST.com’s cost.

Pursuant to the Employee Benefit Matters Agreement, all PC Mall stock options that were outstanding on the record date for the distribution and that had not been exercised prior to the distribution date were converted into two stock options: (1) an option to purchase the number of previously unexercised PC Mall stock options as of the record date, and (2) an option to purchase a number of shares of eCOST.com common stock equal to the number of previously unexercised PC Mall stock options times a fraction, the numerator of which is the total number of shares of our common stock distributed to PC Mall stockholders in the distribution and the denominator of which is the total number of PC Mall shares outstanding on the record date for the distribution. Any outstanding warrants to purchase PC Mall common stock were similarly adjusted under the terms of the Master Separation and Distribution Agreement.

eCOST.com and PC Mall also agreed that, without the other’s consent, for a period of two years following eCOST.com’s initial public offering, neither party nor its affiliates will solicit or hire any employee of the other party who was employed by the other party or its affiliates within six months prior to such solicitation or hiring.

License Agreements

We have entered into two software license agreements to govern the respective rights, responsibilities, and obligations of eCOST.com and us in connection with certain technology and software eCOST.com licenses from us. eCOST.com paid a one-time license fee of $50,000 for one of the software license agreements. The licenses are non-exclusive, non-transferable, non-sublicensable, perpetual, royalty-free licenses for eCOST.com to continue to use the technology and software in a manner substantially similar to its uses prior to the closing of its initial public offering as well as to reproduce, prepare derivative works of, modify and use as reasonably necessary to operate its website. The technology and software is licensed on an “as is” basis.

12.

Commitments and Contingencies

Total rent expense under our operating leases, net of sublease income, was $1.1 million and $1.0 million in each of the three month periods ended September 30, 2006 and 2005 and $3.2 million and $2.9 million in each of the nine month periods ended September 30, 2006 and 2005. Some of our leases contain renewal options and escalation clauses, and require us to pay taxes, insurance and maintenance costs.

Legal Proceedings

On February 3, 2006, a purported class action lawsuit entitledNicole Atkins, et al. v. PC Mall, Inc., et al. was filed in the Superior Court of California, Los Angeles County. The potential class consists of all of our current and former account executives in California. The lawsuit alleges that we improperly classified members of the putative class as “exempt” employees in violation of California’s wage and hour and unfair business practice laws and seeks unpaid overtime, statutory penalties, interest, attorneys’ fees, punitive damages, restitution and injunctive relief. We plan to vigorously defend this litigation. Because the case is in its preliminary stages, we cannot yet predict its outcome and potential financial impact on our business, results of operations and financial condition.

We are not currently a party to any other material legal proceedings. From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other commercial 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.

* * *

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, 2005 filed with the Securities and Exchange Commission, or SEC, on March 31, 2006 and amended on May 1, 2006, our Quarterly Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006 filed with the SEC on May 11, 2006 and August 8, 2006, and all of our other periodic filings, including Current Reports on Form 8-K, filed with the SEC. 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 “we” or “us”), founded in 1987, is a rapid response direct marketer of computer hardware, software, peripherals, electronics, and other consumer products and services. We offer products and services to businesses, government and educational institutions, as well as individual consumers, through dedicated outbound and inbound telemarketing account executives, the Internet, direct marketing techniques, direct response catalogs, a direct sales force and three retail showrooms. We offer a broad selection of products through our distinctive full-color catalogs under the PC Mall, MacMall, and PC Mall Gov brands, our websites pcmall.com, macmall.com, pcmallgov.com, wareforce.com and onsale.com, and other promotional materials.

We operate in two reportable segments: 1) a rapid response supplier of technology solutions for businesses, government and educational institutions, as well as individual consumers, collectively referred to as “Core business” and 2) an online retailer of computer and consumer electronic products under the OnSale.com brand. We allocate resources to and evaluate the performance of our segments based on operating income. Corporate expenses are included in our measure of segment operating income for management reporting purposes.

Management regularly reviews our performance using a variety of financial and non-financial metrics, including sales, shipments, average order size, 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.

We plan to continue to focus our efforts on investing in the training and retention of, and tools provided to, our outbound sales force. This strategy is expected to result in increased expenses associated with the tools and training necessary to achieve those goals, which could have an impact on profitability in the near term.

A substantial portion of our business is dependent on sales of Apple and Apple-related products, HP products, and products purchased from other vendors including Adobe, IBM, Ingram Micro, Lenovo, Microsoft, Sony, Sun Microsystems and Tech Data. Products manufactured by Apple represented 23.3% and 18.5% of our total net sales in the three months ended September 30, 2006 and 2005 and 19.2% and 19.4% of our total net sales in the nine months ended September 30, 2006 and 2005. Products manufactured by HP represented 20.0% and 22.4% of our total net sales in the three months ended September 30, 2006 and 2005 and 22.2% and 21.6% of our total net sales in the nine months ended September 30, 2006 and 2005.

STRATEGIC DEVELOPMENTS

On September 7, 2006, PC Mall Gov, Inc., or PC Mall Gov, our wholly-owned subsidiary, acquired the products business of Government Micro Resources, Inc., or GMRI, for approximately $3.4 million in cash, including transaction costs. The business includes assets of GMRI’s former products business, which include the GMRI trade names, contracts and the related employees, among other items. We are currently reviewing whether certain contingent liabilities existed at the time of the acquisition. We estimate that such contingent liabilities, if any, could result in an increase to the purchase price by approximately $0.1 million to $0.8 million and could increase the amount allocated to goodwill.

Based on a preliminary purchase price allocation, we recorded $2.1 million of goodwill at the Core business segment and $1.3 million of intangible assets and furniture and equipment based on estimated fair values at the date of acquisition. These allocations are subject to further review. Any material adjustment to these allocations could have a material adverse effect on our results of operations in the future.

Beginning with September 8, 2006, the results of the acquired products business of GMRI have been included in the public sector results of the Core business segment.

During the third quarter of 2005, we opened an office in the Philippines, in order to reduce certain of our administrative, back-office and call-center labor costs over time. The opening of the Philippines office has also allowed us to devote additional resources towards enhancing our marketing content on the Internet, and other customer acquisition and retention activities, in an effort to increase sales in a cost-effective manner.

OTHER ITEMS AFFECTING RESULTS OF OPERATIONS

On April 11, 2005, we completed the spin-off of our 80.2% owned subsidiary, eCOST.com, Inc., or eCOST.com, when we distributed approximately 1.2071 shares of eCOST.com common stock as a special dividend on each outstanding share of our common stock to our stockholders of record on March 28, 2005. As a result of the spin-off, eCOST.com, which was a segment of our company, is presented as a discontinued operation for the prior periods presented herein.

Frank F. Khulusi, our President, Chief Executive Officer and Chairman of the Board of Directors, became a greater than 10% stockholder of eCOST.com in April 2005 as a result of the spin-off of eCOST.com to our stockholders. As a result of his direct and indirect beneficial interests in eCOST.com and us, eCOST.com became our related party. Thomas A. Maloof, one of our directors, served as a director of eCOST.com until his resignation from the eCOST.com board in April 2005. In February 2006, Mr. Khulusi became a less than 10% stockholder of eCOST.com.

In April and May 2005, subsequent to the completion of the spin-off of eCOST.com and in connection with its transition from us, our wholly-owned subsidiary, AF Services, LLC (formerly AF Services, Inc.), or AF Services, entered into a product sales agreement and a consignment and product sales agreement with eCOST.com, providing for the sale by AF Services of inventory items to eCOST.com generally at AF Services’ cost. The consignment and product sales agreement terminated in August 2005 and the product sales agreement, which was extended for an additional month, terminated in September 2005. During the period from April 12, 2005 (subsequent to the completion of the eCOST.com spin-off) and the termination of these agreements, we had net sales to eCOST.com of $31.6 million, of which $10.6 million and $30.2 million related to the three and nine months ended September 30, 2005. We do not expect to make significant product sales to eCOST.com in the future.

In September 2004, in connection with the initial public offering of eCOST.com, we and eCOST.com entered into a Master Separation and Distribution Agreement and certain other agreements providing for the separation and the distribution, the provision by us of certain interim services to eCOST.com, and addressing employee benefit arrangements, tax and other matters. The Administrative Services Agreement, under which we provided certain transitional administrative services to eCOST.com, terminated on September 1, 2005 in accordance with the terms of the agreement. We continued to provide certain information technology services to eCOST.com under the Information Technology Systems Usage and Services Agreement. On March 1, 2006, eCOST.com notified us that it has elected to terminate this agreement effective June 30, 2006 in accordance with its termination rights under the agreement. Accordingly, this agreement terminated on June 30, 2006. For a more detailed discussion of the Master Separation and Distribution Agreement and certain other agreements providing for the separation and distribution, you can refer to the information under the heading “Certain Relationships and Related Transactions” in Part III, Item 13 of Amendment No. 1 to our Annual Report on Form 10-K for the year ended December 31, 2005, filed with the SEC on May 1, 2006 and to Note 11 of the Notes to the Consolidated Financial Statements in Part I, Item 1 of this report.

For more information on the discontinued operation of eCOST.com, see Note 3 of the Notes to the Consolidated Financial Statements in Part I, Item 1 of this report.

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, 2005, filed with the SEC on March 31, 2006.

Stock-Based Compensation. On January 1, 2006, we adopted the provisions of Financial Accounting Standards Board, or FASB, Statement No. 123 (revised 2004), “Share-Based Payment,” or SFAS 123R, using the modified prospective transition method. SFAS 123R 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. SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB 25, as we formerly did, and 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 SFAS 123R apply to new stock option grants subsequent to December 31, 2005 and unvested stock options outstanding as of January 1, 2006.

The modified prospective application method requires that compensation expense be recorded for all unvested stock options outstanding at the beginning of the first quarter of adopting SFAS 123R, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” and for new share-based payment awards granted subsequent to our adoption of SFAS 123R, based on the grant date fair value estimated in accordance with SFAS 123R, both adjusted for estimated forfeitures. We estimate the grant date fair value of each stock option grant awarded pursuant to SFAS 123R 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 granted, we applied the simplified method set out in SEC Staff Accounting Bulletin No. 107, “Share-Based Payment,” which was issued in March 2005. We computed 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 was determined using the implied yield on U.S. Treasury issues with a remaining term within the contractual life of the award. In the first quarter of 2006, we estimated 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. Under the modified prospective application method, our prior period financial statements were not restated to retrospectively apply SFAS 123R.

Revenue Recognition. We adhere to the revised guidelines and principles of sales recognition described in Staff Accounting Bulletin No. 104, “Revenue Recognition,” or SAB 104, issued by the staff of the SEC as a revision to Staff Accounting Bulletin No. 101, “Revenue Recognition,” or SAB 101. While the wording of SAB 104 has revised the original SAB 101, “Revenue Recognition”, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. Under SAB 104, 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 collectibility 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 SAB 104 and Emerging Issues Task Force, or 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 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 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 and amortized to advertising expense based on the life of the catalog, which is approximately eight weeks. Other 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 are included in “Prepaid expenses and other current assets” in our Consolidated Balance Sheets.

As we circulate catalogs throughout the year, we receive market development funds and other vendor consideration from vendors included in each catalog. These funds are deferred and recognized based on sales generated over the life of the catalog. We also receive other non-catalog related vendor consideration from our vendors in the form of cooperative marketing allowances, volume incentive rebate programs and other programs to support our marketing of their products. Most of our vendor consideration is recorded as an offset to cost of sales in accordance with EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” or EITF 02-16, since such funds are not a reimbursement of specific, incremental, identifiable costs incurred by us in selling the vendors’ products. Deferred vendor consideration is included in “Accrued expenses and other current liabilities” in our Consolidated Balance Sheets.

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 September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Net sales	$	242,171		$	244,039		$	710,512		$	735,583
Cost of goods sold		210,615			214,546			620,533			650,739

Gross profit		31,556			29,493			89,979			84,844
Selling, general and administrative expenses		27,480			28,169			83,339			87,897

Operating profit (loss)		4,076			1,324			6,640			(3,053	)
Interest expense, net		912			739			2,912			2,067

Income (loss) from continuing operations before income taxes		3,164			585			3,728			(5,120	)
Income tax expense (benefit)		1,256			356			1,480			(1,811	)

Income (loss) from continuing operations		1,908			229			2,248			(3,309	)
Loss from discontinued operation, net of taxes		—			—			—			(1,781	)

Net income (loss)	$	1,908		$	229		$	2,248		$	(5,090	)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold		87.0			87.9			87.3			88.5

Gross profit		13.0			12.1			12.7			11.5
Selling, general and administrative expenses		11.3			11.5			11.8			11.9

Operating profit (loss)		1.7			0.6			0.9			(0.4	)
Interest expense, net		0.4			0.3			0.4			0.3

Income (loss) from continuing operations before income taxes		1.3			0.3			0.5			(0.7	)
Income tax expense (benefit)		0.5			0.2			0.2			(0.3	)

Income (loss) from continuing operations		0.8			0.1			0.3			(0.4	)
Loss from discontinued operation, net of taxes		—			—			—			(0.3	)

Net income (loss)		0.8	%		0.1	%		0.3	%		(0.7	)%

Selected Other Operating Data (in thousands, except sales percentages)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Number of catalogs distributed	3,231		5,266		15,693		18,317
Commercial and public sector sales percentage⁽¹⁾	80.3	%	77.8	%	78.8	%	75.5	%
Consumer sales percentage (includes OnSale.com)⁽¹⁾	19.7	%	22.2	%	21.2	%	24.5	%
Commercial and public sector account executives (at end of period)	606		565		606		565

⁽¹⁾	Excluded from the calculation of the sales percentages as presented herein are $10.6 million and $30.2 of net sales to eCOST.com for the three months and nine months ended September 30, 2005, which sales we discuss in detail below.

Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30, 2005

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


	Three Months Ended September 30,				Change
	2006		2005		$			%
Core business	$	239,889	$	242,928	$	(3,039	)	(1.3	)%
OnSale.com		2,282		1,111		1,171		NMF	⁽¹⁾

Total net sales	$	242,171	$	244,039	$	(1,868	)	(0.8	)%

⁽¹⁾	Not meaningful.

Total net sales for the third quarter of 2006 decreased by $1.9 million, or 0.8%, compared to total net sales for the third quarter of 2005. This decrease was primarily attributable to the $3.0 million decrease in Core business net sales, partially offset by the $1.2 million increase in OnSale.com net sales.

Core business net sales for the third quarter of 2006 decreased by $3.0 million, or 1.3%, compared to the third quarter of 2005. Core business net sales in the third quarter of 2005 included $10.6 million of net sales to eCOST.com under a product sales agreement entered into in April 2005 and a consignment and product sales agreement entered into in May 2005, as discussed above. These sales were generally made to eCOST.com at our cost during the post-spin transition period. Each of these agreements terminated in the third quarter of 2005. Accordingly, no sales were made to eCOST.com during the third quarter of 2006. Without the effect of the net sales to eCOST.com in the third quarter of 2005, Core business net sales increased in the third quarter of 2006 by $7.5 million, or 3.2%, compared to the third quarter of 2005.

We are presenting certain consolidated non-GAAP financial measures, which exclude the sales to eCOST.com, discussed above. We believe the exclusion of such sales from the prior year results allows a more meaningful comparison of our financial results to both management and investors that is indicative of our consolidated operating results across reporting periods because such sales resulted solely as a result of our transition of eCOST.com, and are not expected to reoccur.

In addition, consumer net sales in the third quarter of 2006 decreased by $5.2 million, or 10.3%, to $45.3 million compared to the third quarter of 2005. This 10.3% decrease is an improvement from the 20.5% and 20.7% decreases experienced in the first and second quarters of 2006 compared to the same periods in 2005. This improvement resulted in part from a reduced negative impact on our consumer net sales of Apple’s transition to Intel processors, which was completed in August 2006.

During the third quarter of 2006, our consumer net sales continued to be negatively impacted by competition from direct Apple sales and a 33% reduction of advertising expenditures supporting the consumer market. We continued to reduce our consumer advertising expenditures in an attempt to optimize the return on such expenditures. We expect to periodically adjust such advertising expenditures in the future, and the amount of our advertising expenditures could affect our consumer sales.

The decrease in Core business net sales was offset in part by a growth in commercial net sales of $11.8 million, or 7.6%, to $167.4 million in the third quarter of 2006 compared to the third quarter of 2005. Commercial net sales increased primarily as a result of sales to a single customer which purchased approximately $13.6 million of products during the third quarter of 2006. However, commercial net sales in the third quarter of 2006 were negatively impacted by the effect of one less shipping day in the quarter compared to the third quarter of 2005.

Public sector net sales increased by $1.1 million, or 4.1%, to $27.1 million in the third quarter of 2006 compared to the third quarter of 2005, primarily due to the $7.6 million of net sales resulting from the products business acquired from GMRI on September 7, 2006, partially offset by a $6.5 million decrease in net sales due to competitive pricing pressures in the marketplace continuing from the second half of 2005 and softness in sales under existing contracts.

OnSale.com net sales for the third quarter of 2006 were $2.3 million, an increase of $1.2 million compared to the third quarter of 2005, resulting primarily from our increased marketing efforts to promote the OnSale.com brand beginning in the latter part of the third quarter of 2005. We expect OnSale.com’s net sales to decrease in the fourth quarter as compared to the fourth quarter of 2005 due to decreases in planned advertising expense as compared to the fourth quarter of 2005 in an effort to optimize its operating results.

Total sales of products manufactured by Apple and HP represented 23.3% and 20.0% of total net sales for the third quarter of 2006 compared to 18.5% and 22.4% of total net sales for the third quarter of 2005.

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


	Three Months Ended September 30,
	2006				2005				Change
	Gross Profit		Gross Profit Margin		Gross Profit		Gross Profit Margin		$		Margin
Core business	$	31,183	13.0	%	$	29,370	12.1	%	$	1,813	0.9	%
OnSale.com		373	16.3	%		123	11.1	%		250	5.2	%

Total gross profit and gross profit margin	$	31,556	13.0	%	$	29,493	12.1	%	$	2,063	0.9	%

Total gross profit for the third quarter of 2006 increased by $2.1 million, or 7.0%, compared to the total gross profit for the third quarter of 2005. Total gross profit margin for the third quarter of 2006 increased by 0.9% compared to the third quarter of 2005. The increase in total gross profit and gross profit margin in the third quarter of 2006 compared to the same period last year resulted primarily from the $1.8 million increase in Core business gross profit and 0.9% increase in Core business gross profit margin.

The increase in Core business gross profit of $1.8 million for the third quarter of 2006 compared to the third quarter of 2005 was primarily the result the acquisition of the products business from GMRI discussed above, as well as increased consideration received from vendors during the quarter. The increase in Core business gross profit margin of 0.9% in the third quarter of 2006 compared to the same period in the prior year was primarily due to a 66 basis point increase in vendor consideration and a 52 basis point increase related to the sales in the prior year to eCOST.com generally at our cost.

In the fourth quarter of 2006, we, together with other channel resellers, were notified that a vendor consideration program which contributed approximately $2.8 million and $4.1 million during the three and nine months ended September 30, 2006 will be significantly reduced beginning in the fourth quarter of 2006. Our goal is to offset as much of this decrease as possible via a combination of the elimination of advertising and administrative costs associated with the program and increases in other vendor consideration. We expect our gross profit margin to decline from the third quarter of 2006 as a result of decreased vendor consideration as a percent of net sales. Vendor programs are periodically discontinued and new programs are created, requiring us to modify our efforts accordingly. Factors which may cause our gross profit and gross profit margin to vary in future periods include the continuation of key vendor support programs (including price protections, rebates, return policies and other consideration), our product or customer mix, product acquisition and shipping costs, competition and other factors.

Gross profit for OnSale.com for the third quarter of 2006 was $0.4 million, an increase of $0.3 million compared to the third quarter of 2005, primarily due to an increase in its net sales and an increase in its vendor consideration of $0.2 million. OnSale.com’s gross profit margin for the third quarter of 2006 increased to 16.3% compared to 11.1% in the third quarter of 2005, primarily due to significant vendor consideration received as a percentage of OnSale.com’s net sales. We expect OnSale.com’s vendor consideration as a percentage of net sales to decline going forward.

Selling, General and Administrative Expenses. The following table presents our selling, general and administrative, or SG&A, expenses, by segment, for the periods presented (in thousands):


	Three Months Ended September 30,
	2006				2005				Change
	SG&A		SG&A as a % of Sales		SG&A		SG&A as a % of Sales		$			%		SG&A as a % of Sales
Core business	$	26,833	11.2	%	$	27,501	11.3	%	$	(668	)	(2.4	)%	(0.1	)%
OnSale.com		647	28.4	%		668	60.1	%		(21	)	(3.1	)%	(31.7	)%

Total SG&A expenses	$	27,480	11.3	%	$	28,169	11.5	%	$	(689	)	(2.4	)%	(0.2	)%

Total SG&A expenses decreased by $0.7 million, or 2.4%, in the third quarter of 2006 compared with the third quarter of 2005. SG&A expenses in the third quarter of 2006 include $0.6 million of SG&A expenses of the acquired products business of GMRI. As a percent of net sales, total SG&A expenses decreased to 11.3% in the third quarter of 2006 from 11.5% in the third quarter of 2005. The decrease in total SG&A expenses was primarily due to the $0.7 million decrease in Core business SG&A expenses.

Core business personnel costs (excluding non-cash stock-based compensation expense) declined $0.9 million principally due to continued labor cost savings. In addition, core business advertising costs declined $1.2 million as a result of our efforts to optimize the return on our advertising expenditures. These declines in Core business SG&A were partially offset by the $0.6 million of SG&A expenses related to GMRI discussed above, $0.4 million of non-cash stock-based compensation expense in the third quarter of 2006 resulting from our prospective adoption of SFAS 123R on January 1, 2006 and an increase of $0.3 million of facility costs.

As a percent of net sales, SG&A expenses for Core business decreased to 11.2% in the third quarter of 2006 compared with 11.3% in the third quarter of the prior year. Excluding net sales to eCOST.com of $10.6 million as discussed above in the three months ended September 30, 2005, SG&A expenses as a percent of net sales for Core business decreased by 0.6% to 11.2% in the third quarter of 2006 compared with non-GAAP SG&A expenses as a percent of net sales of 11.8% in the third quarter of the prior year. The non-GAAP 0.6% decrease in Core business SG&A expenses as a percent of net sales was primarily due to a 58 basis point decline in personnel costs and a 53 basis point decline in advertising expenditures as a percent of net sales, partially offset by the 15 basis point increase in SG&A expenses as a percent of net sales related to the non-cash stock-based compensation expense recognized in the third quarter of 2006. The $10.6 million of net sales to eCOST.com had a negative impact of 52 basis points on SG&A as a percent of net sales in the third quarter of 2006 compared to the third quarter of 2005.

OnSale.com SG&A expenses were $0.6 million in each of the third quarters of 2006 and 2005. OnSale.com’s advertising expenditures increased by $0.3 million during the third quarter of 2006 compared to the third quarter of 2005 related to our increased marketing efforts to promote the OnSale.com brand. This increase in advertising expenditures was offset by a $0.2 million decrease in personnel costs. OnSale.com SG&A expenses as a percent of net sales declined to 28.4% in the third quarter of 2006 compared to 60.1% in the third quarter of 2005, primarily as a result of increased sales.

Net Interest Expense.Total net interest expense for the third quarter of 2006 increased to $0.9 million compared with $0.7 million in the third quarter of 2005. The increased interest expense resulted from higher interest rates during the third quarter of 2006 compared to the third quarter of 2005, offset in part by decreased average daily borrowings. If interest rates continue to rise in the future, we would expect interest expense on our borrowings to increase.

Income Tax Expense.We recorded an income tax expense of approximately $1.3 million in the third quarter of 2006 compared to an income tax expense of $0.4 million in the third quarter of 2005. Our effective tax rates for the quarters ended September 30, 2006 and 2005 were approximately 40% and 61%. The increase in income tax expense for the third quarter of 2006 compared to the third quarter of 2005 was due to the increase in income from continuing operations before income taxes.

Nine Months Ended September 30, 2006 Compared to the Nine Months Ended September 30, 2005

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


	Nine Months Ended September 30,				Change
	2006		2005		$			%
Core business	$	700,396	$	732,282	$	(31,886	)	(4.4	)%
OnSale.com		10,116		3,301		6,815		NMF

Total net sales	$	710,512	$	735,583	$	(25,071	)	(3.4	)%

Total net sales for the nine months ended September 30, 2006 decreased by $25.1 million, or 3.4%, compared to same period of 2005. This decrease was primarily attributable to the $31.9 million decrease in Core business net sales, partially offset by the $6.8 million increase in OnSale.com net sales.

Core business net sales for the nine months ended September 30, 2006 decreased by $31.9 million, or 4.4%, compared to the nine months ended September 30, 2005. Core business net sales for the nine months ended September 30, 2005 included $30.2 million of net sales to eCOST.com under a product sales agreement entered into in April 2005 and a consignment and product sales agreement entered into in May 2005, as discussed above. These sales were generally made to eCOST.com at our cost during the post-spin transition period. Each of these agreements terminated in the third quarter of 2005. Accordingly, no sales were made to eCOST.com during the nine months ended September 30, 2006. Without the effect of the net sales to eCOST.com for the nine months ended September 30, 2006, Core business net sales decreased by $1.7 million, or 0.2%, in the nine months ended September 30, 2006 compared to the same period in 2005.

In addition, consumer net sales for the nine months ended September 30, 2006 decreased by $29.7 million, or 17.6%, to $139.6 million compared to the nine months ended September 30, 2005. During the nine months ended September 30, 2006, advertising expenditures supporting the consumer market decreased 18%. We continued to reduce our consumer advertising expenditures in an attempt to optimize the return on such expenditures. We expect to periodically adjust such advertising expenditures in the future, and the amount of our advertising expenditures could affect our consumer sales. Further, we continued to be negatively impacted by competition from direct Apple sales.

We believe our consumer net sales during the third quarter of 2006 were less impacted by Apple’s transition to Intel processors than during the previous two quarters of 2006. Apple completed its transition to Intel processors in August 2006.

Public sector net sales decreased by $4.1 million, or 6.4%, to $59.4 million in the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, primarily due to the competitive pricing pressures in the marketplace continuing from the second half of 2005 and softness in sales under existing contracts, partially offset by an increase in net sales of $7.6 million resulting from the products business acquired from GMRI on September 7, 2006.

The decreases in Core business net sales were offset in part by a growth in commercial net sales of $31.7 million, or 6.8%, to $500.7 million for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. The commercial net sales increase includes sales to a single customer which purchased approximately $13.6 million of products during the third quarter of 2006.

OnSale.com net sales for the nine months ended September 30, 2006 were $10.1 million, an increase of $6.8 million compared to the nine months ended September 30, 2005, resulting primarily from our increased marketing efforts to promote the OnSale.com brand beginning in the latter part of the third quarter of 2005.

Total sales of products manufactured by HP and Apple represented 22.2% and 19.2% of total net sales for the nine months ended September 30, 2006 compared to 21.6% and 19.4% of total net sales for the nine months ended September 30, 2005.

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


	Nine Months Ended September 30,								Change
	2006				2005				Change
	Gross Profit		Gross Profit Margin		Gross Profit		Gross Profit Margin		$		Margin
Core business	$	88,670	12.7	%	$	84,610	11.6	%	$	4,060	1.1	%
OnSale.com		1,309	12.9	%		234	7.1	%		1,075	5.8	%

Total gross profit and gross profit margin	$	89,979	12.7	%	$	84,844	11.5	%	$	5,135	1.2	%

Total gross profit for the nine months ended September 30, 2006 increased by $5.1 million, or 6.1%, compared to total gross profit for the nine months ended September 30, 2005. Total gross profit margin for the nine months ended September 30, 2006 increased by 1.2% compared to the nine months ended September 30, 2005. The increase in total gross profit and total gross profit margin in the nine months ended September 30, 2006 compared to the same period last year resulted primarily from the $4.1 million increase in Core business gross profit and 1.1% increase in Core business gross profit margin.

The increase in Core business gross profit of $4.1 million for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 was primarily the result the acquisition of the products business from GMRI discussed above, as well as increased consideration received from vendors during the current period. The increase in Core business gross profit margin of 1.1% in the nine months ended September 30, 2006 compared to the same period in the prior year was primarily due to a 61 basis point increase in vendor consideration and a 48 basis point increase related to the sales in the prior year to eCOST.com generally at our cost.

will be significantly reduced beginning in the fourth quarter of 2006. Our goal is to offset as much of this decrease as possible via a combination of the elimination of advertising and administrative costs associated with the program and increases in other vendor consideration. We expect our gross profit margin to decline from the third quarter of 2006 as a result of decreased vendor consideration as a percent of net sales. Vendor programs are periodically discontinued and new programs are created, requiring us to modify our efforts accordingly. Factors which may cause our gross profit and gross profit margin to vary in future periods include the continuation of key vendor support programs (including price protections, rebates, return policies and other consideration), our product or customer mix, product acquisition and shipping costs, competition and other factors.

Gross profit for OnSale.com for the nine months ended September 30, 2006 was $1.3 million, an increase of $1.1 million compared to the nine months ended September 30, 2005, primarily due to an increase in its net sales and an increase in its vendor consideration of $0.6 million. OnSale.com’s gross profit margin for the nine months ended September 30, 2006 increased to 12.9% compared to 7.1% in the nine months ended September 30, 2005, primarily due to significant vendor consideration received as a percentage of OnSale.com’s net sales. We expect OnSale.com’s vendor consideration as a percentage of net sales to decline going forward.

Selling, General and Administrative Expenses. The following table presents our selling, general and administrative (“SG&A”) expenses, by segment, for the periods presented (in thousands):


	Nine Months Ended September 30,
	2006				2005				Change
	SG&A		SG&A as a % of Sales		SG&A		SG&A as a % of Sales		$			%		SG&A as a % of Sales
Core business	$	80,916	11.6	%	$	86,001	11.7	%	$	(5,085	)	(5.9	)%	(0.1	)%
OnSale.com		2,423	24.0	%		1,896	57.4	%		527		27.8	%	(33.4	)%

Total SG&A expenses	$	83,339	11.7	%	$	87,897	11.9	%	$	(4,558	)	(5.2	)%	(0.2	)%

Total SG&A expenses decreased by $4.6 million, or 5.2%, in the nine months ended September 30, 2006 compared with the nine months ended September 30, 2005. As a percent of net sales, total SG&A expenses decreased to 11.7% in the nine months ended September 30, 2006 from 11.9% in the nine months ended September 30, 2005. The decrease in total SG&A expenses was primarily due to the $5.1 million decrease in Core business SG&A expenses, partially offset by a $0.5 million increase in OnSale.com SG&A expenses.

Core business personnel costs (excluding non-cash stock-based compensation expense) declined $4.1 million principally due to continued labor cost savings. In addition, Core business advertising costs declined $2.2 million as a result of our efforts to optimize the return on our advertising expenditures, credit card related fees declined $1.3 million, and audit and audit-related fees declined $0.7 million. These declines in core business SG&A were partially offset by $1.2 million of non-cash stock-based compensation expense in the nine months ended September 30, 2006 resulting from our prospective adoption of SFAS 123R on January 1, 2006, a $0.7 million reduction in administrative and fulfillment service charges to eCOST.com compared to the same period in the prior year, the $0.6 million of SG&A expenses related to GMRI discussed above and an increase of $0.6 million of facility costs.

As a percent of net sales, SG&A expenses for Core business decreased to 11.6% in the nine months ended September 30, 2006 compared with 11.7% in the same period of prior year. Excluding net sales to eCOST.com of $30.2 million as discussed above in the nine months ended September 30, 2005, SG&A expenses as a percent of net sales for Core business decreased by 0.6% to 11.6% in the nine months ended September 30, 2006 compared with non-GAAP SG&A expenses as a percent of net sales of 12.2% in the same period of the prior year. The non-GAAP 0.6% decrease in Core business SG&A expenses as a percent of net sales was primarily due to a 57 basis point decline in personnel costs and a 31 basis point decline in advertising expenditures as a percent of net sales, partially offset by a 17 basis point increase in SG&A expenses as a percent of net sales related to the non-cash stock-based compensation expense recognized in nine months ended September 30, 2006. The $30.2 million of net sales to eCOST.com had a negative impact of 50 basis points on SG&A as a percent of net sales in the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005.

OnSale.com SG&A expenses in the nine months ended September 30, 2006 were $2.4 million, an increase of $0.5 million from the nine months ended September 30, 2005. The increase of $0.5 million in OnSale.com’s SG&A expenses was primarily due to a $0.8 million increase in advertising expenditures related to our increased marketing efforts to promote the OnSale.com brand and a $0.2 million increase in credit card related fees, partially offset by a decrease of $0.5 million in personnel costs. OnSale.com SG&A expenses as a percent of net sales declined to 24.0% in the nine months ended September 30, 2006 compared to 57.4% in the nine months ended September 30, 2005, primarily as a result of increased sales.

Net Interest Expense.Total net interest expense for the nine months ended September 30, 2006 increased to $2.9 million compared with $2.1 million in the same period of 2005. The increase in interest expense resulted from higher interest rates during the first nine months of 2006 compared to the first nine months of 2005, partially offset by decreased average daily borrowings. If interest rates continue to rise in the future, we would expect interest expense on our borrowings to increase.

Income Tax Expense (Benefit).We recorded an income tax expense of approximately $1.5 million for the nine months ended September 30, 2006 compared to an income tax benefit of $1.8 million for the nine months ended September 30, 2005. Our effective tax rates for the nine month periods ended September 30, 2006 and 2005 were approximately 40% and 35%. The increase in income tax expense for the nine months ended September 30, 2006 compared to the income tax benefit for the nine months ended September 30, 2005 was due to the increase in income from continuing operations before income taxes, partially offset by an increase in our annual effective tax rate in the current period due to higher expected state and foreign tax rates in the current year compared to the prior year.

Loss from Discontinued Operation.Loss from discontinued operation, net of taxes, which included the results of operation of eCOST.com, was $1.8 million for the nine months ended September 30, 2005. We completed the eCOST.com spin-off in April 2005 and accordingly, we recognized no income (loss) from the discontinued operation of eCOST.com in the nine months ended September 30, 2006.

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. 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. We believe that our current working capital, including our existing cash balance, together with our 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 twelve months. In the remainder of 2006, our efforts to focus on commercial and public sector sales could result in an increase in our accounts receivable as these customers are generally provided longer payment terms. In addition, we expect to continue to focus our efforts on increasing the productivity of our sales force and reducing our infrastructure costs, as well as ramping up our offshore operations, in an effort to reduce our costs.

We had cash and cash equivalents of $6.9 million at September 30, 2006 and $6.3 million at December 31, 2005. Our working capital increased by $3.2 million to $38.8 million at September 30, 2006 from working capital of $35.6 million at December 31, 2005.

Our capital expenditures were $2.7 million during the nine months ended September 30, 2006, compared to $2.5 million during the nine months ended September 30, 2005. We expect that our primary capital needs will continue to be the funding of our existing working capital requirements, possible sales growth, and possible acquisitions and new business ventures.

In June 2003, we established a call center in Montreal, Canada, serving the U.S. market. We believe that the Canadian call center allows us to access an abundant, educated labor pool and benefit from a Canadian government labor subsidy that extends through approximately the end of 2007. During the years through 2007, we expect to annually claim labor credits of up to 35% of eligible compensation for qualifying employees under the program. In July 2006, we received the expected $2.4 million of payment from the Canadian government related to our 2004 claim. As of September 30, 2006, we had an accrued receivable of $5.7 million related to these labor credits recorded in “Prepaid expenses and other current assets” on our Consolidated Balance Sheets and we expect to receive full payment under our claim.

In the future, 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, we may seek additional financing from public or private debt or equity financings; however, there can be no assurance that such financing will be available at acceptable terms, if at all. To the extent any such financings involve the issuance of equity securities, existing stockholders could experience dilution.

Cash Flows from Operating Activities.Net cash provided by operating activities from continuing operations was $33.2 million in the nine months ended September 30, 2006, compared to $14.4 million in the nine months ended September 30, 2005. The $33.2 million net cash provided by operating activities from continuing operations in the current period resulted primarily from a $24.5 million decrease in inventories reflecting our efforts to optimize inventory levels, seasonality and our sell-through of year-end strategic buys for the holidays from the prior year end, a $12.2 million increase in accounts payable

primarily due to the acquisition of the products business from GMRI in September 2006, partially offset by a $13.7 million increase in accounts receivable primarily due to receivables generated by the new GMRI products business we acquired and an increase in receivables from our vendors.

Net cash provided by operating activities from continuing operations of $14.4 million in the nine months ended September 30, 2005 resulted primarily from a $27.5 million decrease in inventory reflecting our efforts to optimize inventory levels, sell-seasonality and our sell-through of year-end strategic buys for the holidays, partially offset by a $1.9 million decrease in accounts payable reflecting our aggressive pursuit of vendor early-pay discounts, a $4.8 million increase in accounts receivable primarily due to increased open account sales, a $2.0 million decrease in accrued expenses and other current liabilities relating to the decreased accruals for freight costs, sales taxes and marketing expenditures and the $3.3 million of loss from continuing operations in the nine months ended September 30, 2005.

Cash Flows from Investing Activities.Net cash used in investing activities from continuing operations was $6.0 million in the nine months ended September 30, 2006, compared to $2.5 million in the nine months ended September 30, 2005. The $6.0 million of net cash used in investing activities in the nine months ended September 30, 2006 resulted from $2.7 million of capital expenditures relating to the continued expansion of our Philippines office, as well as the creation of enhanced electronic tools for our account executives and sales support staff, and $3.4 million related to the acquisition of the products business from GMRI in September 2006. The $2.5 million net cash used in investing activities in the nine months ended September 30, 2005 resulted from capital expenditures related to the replacement and improvement of our servers and personal computers.

Cash Flows from Financing Activities.Net cash used in financing activities from continuing operations for the nine months ended September 30, 2006 was $26.9 million, compared to $12.8 million in the nine months ended September 30, 2005. The $26.9 million of net cash used in financing activities in the current nine months ended September 30, 2006 was primarily related to $29.7 million of net payments of our outstanding balance on our line of credit, partially offset by a $2.7 million increase in book overdraft, which were both due to the timing of outstanding payments to vendors relative to the prior period. The $12.8 million of net cash used in financing activities in the nine months ended September 30, 2005 was primarily related to the $11.9 million of net payments of our outstanding balance on our line of credit and a $0.9 million decrease in book overdraft.

Line of Credit and Note Payable.We maintain a $100 million asset-based revolving credit facility from a lending unit of a large commercial bank, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables. The credit facility has a maturity date of March 2008, bears interest at the prime rate or an option to select the London Interbank Offered Rate, or LIBOR, plus a spread of 2.0% or 2.50%, depending on certain earning targets, and also includes a commitment fee of 0.25% annually on the unused portion of the line up to $60 million, unless the outstanding borrowings under the credit facility exceed $75 million, at which time the unused line fees will be assessed on the unused portion of the facility up to $80 million. At September 30, 2006, our effective weighted average interest rate was 7.90% and we had $23.8 million of net working capital advances outstanding under the line of credit. At September 30, 2006, we had $27.9 million available to borrow for working capital advances under the line of credit.

The credit facility is secured by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have a security interest in some of our assets related to their products. The credit facility has as its single financial covenant a minimum tangible net worth requirement, which we were in compliance with at September 30, 2006. 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 early-pay discounts.

As part of our growth strategy, we may, in the future, acquire other companies 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 operations of the acquired company would place additional demands on our management, operating and financial resources.

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 not paid cash dividends on our capital stock and we do not currently anticipate paying dividends in the future. We intend to retain our earnings to finance the growth and development of our business.

Off-Balance Sheet Arrangements

As of September 30, 2006, we did not have any off-balance sheet arrangements.

Contingencies

For a discussion of contingencies, see Part I, Item 1, Note 12 of the Notes to the Consolidated Financial Statements of this report, which are 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, including the Management’s Discussion and Analysis above, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our industry, our beliefs and assumptions. We use words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” and variations of these words and similar expressions to identify forward-looking statements. Such statements include statements regarding our expectations, hopes or intentions regarding the future, including but not limited to, statements regarding: our expectations about the timing of our recognition of compensation costs related to unvested outstanding stock options; our plans to continue to invest in our outbound sales force and our expected results from that investment; our office in the Philippines and our belief that it should provide us an opportunity to reduce certain costs over time; our focus on commercial and public sector sales and its impact; the impact of our Canadian call center on operating results and the amount and timing of related subsidies; our expectation that we will not make significant product sales to eCOST.com in the future; the effect of material sales to a single customer; our expectations regarding the effect on our consumer sales of Apple’s transition to Intel processors; the level of advertising expenditures and the resulting impact on our results of operations; the impact of the loss of vendor consideration program constituting $2.8 million in the third quarter of 2006 and our ability to offset such loss with other vendor consideration; the impact of competition, including competing sales by some of our largest vendors; the sufficiency of our capital resources and potential needs for and availability of additional financing; our expected capital needs; our expectation that we will continue to focus on increasing sales force productivity, reducing infrastructure costs and increasing offshore operations; our growth strategy, including the possibility of acquisitions and new business ventures and their impact on our resources; the impact of changes in interest rates; our plans regarding pending litigation; and our anticipation regarding future dividend payments. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.

These risks and uncertainties include, but are not limited to, the following:

•

our revenues are dependent on sales of products from a small number of vendors, and the loss of any key vendor, a decline in sales of their products or pricing pressures could materially impact our business;

•

our success is dependent in part upon the ability of our vendors to develop and market products that meet the changing requirements of the marketplace and our ability to sell popular products;

•

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

•

our operating results and cash flow could be materially harmed by declines in key vendor incentives and other assistance;

•

the transition of our business strategy to increase our commercial and public sector sales and our increased infrastructure investments in and focus on our outbound telemarketing sales models may not improve our profitability or result in expanded market share;

•

the success of our Canadian call center is dependent on our receipt of government credits;

•

we have limited experience operating in the Philippines, which could prevent us from realizing expected cost savings or other expected benefits;

•

we may need additional or continued financing from third party investors or our vendors for potential acquisitions, working capital requirements or for other purposes, and we may not be able to raise or maintain such financing on favorable terms or at all;

•

we cannot determine with any certainty the costs or outcome of pending or future litigation;

•

our advertising, marketing and promotional efforts may be costly and may not achieve desired results; and

•

we may not be able to compete successfully against existing or future competitors, which include some of our largest vendors.

The foregoing list of risks is not intended to be exhaustive. We also face additional risks, including but not limited to those discussed elsewhere in this report, and in particular those discussed under the heading “Risk Factors” in Part II, Item 1A of this report. Reference should also be made to the factors set forth from time to time in our reports filed with the SEC. All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update or revise any of these forward-looking statements even if our experience or future changes show that the indicated results or events will not be realized.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financial instruments include cash and cash equivalents and long-term debt. At September 30, 2006, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.

We have exposure to the risks of fluctuating interest rates on our line of credit and note payable. The variable interest rate on our line of credit and note payable is tied to the prime rate or the LIBOR, at our discretion. At September 30, 2006, we had $23.8 million outstanding under our line of credit and $2.4 million outstanding under our note payable. As of September 30, 2006, the hypothetical impact of a one percentage point increase in interest rate related to the outstanding borrowing under our line of credit would be to increase annual interest expense by $0.3 million.

It is our policy not to enter into derivative financial instruments, and we do not have any significant foreign currency exposure. Therefore, we did not have significant overall currency exposure as of September 30, 2006.

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 September 30, 2006.

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 third quarter of 2006 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

Material pending legal proceedings to the business, to which we became or were a party during the quarter ended September 30, 2006 or subsequent thereto, but before the filing of this report, are summarized below:

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. You should carefully consider the risks and uncertainties facing our business which are set forth below. These risks include any material changes to and supersede the risks previously disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. The risks described below are not the only ones facing us. Our business is also subject to the 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.

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, including Apple, HP, Lenovo, Microsoft and Sony. For example, products manufactured by HP accounted for approximately 20.0% and 22.4% of our total net sales in the third quarter of 2006 and 2005 and 22.2% and 21.6% of our total net sales in the nine months ended September 30, 2006 and 2005, and products manufactured by Apple accounted for approximately 23.3% and 18.5% of our total net sales in the third quarter of 2006 and 2005 and 19.2% and 19.4% of our total net sales in the nine months ended September 30, 2006 and 2005. 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. In the near term, Apple’s transition to Intel processors could continue to negatively impact our consumer sales.

Certain of our key 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 key vendors, including Apple, HP, IBM, Ingram Micro, Lenovo, Microsoft, Sony and Tech Data, provide us with trade credit or substantial incentives in the form of discounts, credits and cooperative advertising. We have agreements with most of our key 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.

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, the personal computer 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 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, we are an authorized dealer for the full retail line of HP products, sales of which represented 20.0% and 22.2% of our total net sales in the third quarter and nine month period ended September 30, 2006, and Apple products, sales of which represented 23.3% and 19.2% of our total net sales in the third quarter and nine month period ended September 30, 2006, but 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.

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 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 terminate our right to sell some or all of their products, 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. Our narrow gross margins magnify the impact of variations in our operating costs and of adverse or unforeseen events on our operating results. 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 frequency of our catalog mailings, introduction or discontinuation of new catalogs, the introduction of new products or services by us and our competitors, changes in prices from our suppliers, the loss or consolidation of significant suppliers or customers, general competitive conditions such as pricing, our ability to control costs, the timing of our capital expenditures, the condition of the personal computer and electronics 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,adverse weather conditions that affect response, distribution or shipping to our customers, and general economic conditions 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 should not be relied upon as an 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 business and public sector sales presents numerous risks and challenges, and may not improve our profitability or result in expanded market share.

Our business strategy is to increasingly focus on commercial 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 business 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.

Our increased investments in our outbound telemarketing 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 the growth, training and retention of our outbound telemarketing sales force. We have also incurred, and expect to continue to incur, significant expenses related to infrastructure investments related to this growth in our outbound telemarketing sales force. We cannot assure you that any of our investments in our outbound telemarketing sales force will result in expanded market share or increased profitability in the near or long term.

The success of our Canadian call center is dependent, in part, on our receipt of government labor credits.

In June 2003, we established a Canadian call center serving the U.S. market. One of the benefits we receive from having our Canadian call center is that we can claim Canadian government labor credits on eligible compensation paid to qualifying employees at the call center. The term of the government program that provides for these labor credits is currently scheduled to extend through approximately the end of 2007. During the period through 2007, we expect to annually claim labor credits of up to 35% of eligible compensation paid to our qualifying employees under the program. The success of our Canadian call center is dependent, in part, on our receipt of the government labor credits we expect to receive. While management believes the amounts claimed are collectible, if we do not receive these expected labor credits, or a sufficient portion of them, then the costs of operating our Canadian call center may exceed the benefits it provides us and our operating results would likely suffer.

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 was quite limited (e.g., visiting the state several times a year to aid customers or to inspect showrooms stocking their goods). We believe our operations 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 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.

Furthermore, we are subject to general business regulations and laws, as well as regulations and laws specifically governing companies that do business over the Internet. Such existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation of e-commerce, 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, unauthorized access (including the Computer Fraud and Abuse Act), and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel, trespass, data mining and collection, and personal privacy, among other laws, apply to the Internet and e-commerce. Unfavorable resolution of these issues may expose us to liabilities and costly changes in our business operations, and could reduce customer demand for our products. 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. For example, legislation in California requires us to notify our California customers if certain personal information about them is obtained by an unauthorized person, such as a computer hacker. These consumer protection laws could result in substantial compliance costs and could decrease our profitability.

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.

We have pursued in the past, and may pursue in the future, acquisitions of companies that either complement or expand our existing business. No assurance can be given that the benefits we may expect from the acquisition of complementary or supplementary companies will be realized. 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 systems, potential short-term adverse effects on our operating results and the amortization of acquired intangible assets. Any delays or unexpected costs incurred in connection with the integration of acquired companies could have a material adverse effect on our business, financial condition and results of operations. Furthermore, we cannot assure you that we will be able to implement or sustain our acquisition strategy or that our strategy will ultimately prove profitable.

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 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 maintain customer acquisition costs at acceptable levels. 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 we project. In addition, we may find that our business plan costs more to execute than we currently anticipate. Some of the factors that affect our ability to maintain profitability on a quarterly or annual basis are beyond our control.

The effect of the change in 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. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment,” which requires 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. We adopted SFAS 123R on January 1, 2006. The recognition of non-cash stock-based compensation expenses in our consolidated statements of operations had and will 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.

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:

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

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

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fluctuations in mail-in rebate redemption rates;

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the amount and timing of advertising and marketing costs;

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

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

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technical difficulties, including system or Internet failures;

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fluctuations in the demand for our products or overstocking or understocking of our products;

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

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fluctuations in shipping costs, particularly during the holiday season;

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economic conditions generally or economic conditions specific to the Internet, e-commerce, the retail industry or the mail order industry;

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changes in the mix of products that we sell; and

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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 most 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 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 twelve months. However, if we need additional financing, such as for acquisitions or expansion or to fund 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.

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 the prime rate, with a LIBOR option, plus a spread of 2.0% or 2.50% depending on certain earnings targets. In connection with and as part of the line of credit, we also entered into a term note, bearing interest at the prime rate with a LIBOR option. 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 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.

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 commercial litigation related to the conduct of our business. For example, we are currently a defendant in a purported class action lawsuit which alleges that we improperly classified certain current and former employees as “exempt” employees in violation of California law. 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. 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 merchandise categories, product offerings, websites and 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 merchandise categories, product offerings, websites and 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 able to or successful in implementing any such changes when and if they are required.

We have generated substantially all of our revenue in the past from the sale of computer hardware, software and accessories and consumer electronics products. Expansion into new product 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 product 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 categories include our ability to:

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establish or increase awareness of our new brands and product categories;

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acquire, attract and retain customers at a reasonable cost;

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

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attract a sufficient number of new customers to whom our new product categories are targeted;

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successfully market our new product offerings to existing customers;

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maintain or improve our gross margins and fulfillment costs;

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attract and retain vendors to provide our expanded line of products to our customers on terms that are acceptable to us; and

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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.

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 will continue to document and test our internal control procedures on an ongoing basis in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of internal controls over financial reporting and a report by an independent registered public accounting firm addressing such assessments if applicable. During the course of our testing, we may from time to time identify deficiencies which we may not be able to remediate. In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. 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.

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.

Our business strategy is to increasingly focus on commercial and public sector sales. During the most recent economic downturn in the U.S. and elsewhere, businesses and public sector entities generally reduced, often substantially, their rate of information technology spending. 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 hinder our growth.

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 products that are shipped to our customers directly from our vendors. If our actual product returns significantly exceed our allowances for returns, our revenue and profitability could decrease. In addition, because our allowances are based on historical return rates, the introduction of new merchandise categories, new products, changes in our product mix, or other factors may cause actual returns to exceed return allowances, perhaps significantly. In addition, any policies that we adopt that are intended to reduce the number of product returns may result in customer dissatisfaction and fewer repeat customers.

Our business may be harmed by fraudulent activities on our websites, including fraudulent credit card transactions.

We have received in the past, and anticipate that we will receive in the future, communications from customers due to purported fraudulent activities on our websites, including fraudulent credit card transactions. Negative publicity generated as a result of fraudulent conduct by third parties could damage our reputation and diminish the value of our brand name. Fraudulent activities on our websites could also subject us to losses and could lead to scrutiny from lawmakers and regulators regarding the operation of our websites. We expect to continue to receive requests from customers for reimbursement due to purportedly fraudulent activities or threats of legal action against us if no reimbursement is made.

We may be liable for misappropriation of our customers’ personal information.

If third parties or our employees are able to penetrate our network security or otherwise misappropriate our customers’ personal information or credit card information, or if we give third parties or our employees improper access to our customers’ personal information or credit card information, we could be subject to liability. This liability could include claims for unauthorized purchases with credit card information, identify theft or other similar fraud-related claims. This liability could also include claims for other misuses of personal information, including for unauthorized marketing purposes. Other liability could include claims alleging misrepresentation or our privacy and data security practices. Any such liability for misappropriation of this information could decrease our profitability. In addition, the Federal Trade Commission and state agencies have been investigating various Internet companies regarding whether they misused or inadequately secured personal information regarding consumers. We could incur additional expenses if new laws or regulations regarding the use of personal information are introduced or if government agencies investigate our privacy practices.

We seek to rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary to effect secure online transmission of confidential information such as customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other events or developments may result in a compromise or breach of the algorithms that we use to protect sensitive customer transaction data. A party who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Our security measures are designed to protect against security breaches, but our failure to prevent such security breaches could subject us to liability, damage our reputation and diminish the value of our brand-name.

Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet business or our marketing efforts.

We mail catalogs and send electronic messages to names in our proprietary customer database and to potential customers whose names we obtain from rented or exchanged mailing lists. Worldwide public concern regarding personal privacy has subjected the rental and use of customer mailing lists and other customer information to increased scrutiny and regulation. As a result, we are subject to increasing regulation relating to privacy and the use of personal information. For example, we are subject to various telemarketing and anti-spam laws that regulate the manner in which we may solicit future suppliers and customers. Such regulations, along with increased governmental or private enforcement, may increase the cost of operating and growing our business. In addition, several states have proposed legislation that would limit the uses of personal information gathered online or require online services to establish privacy policies. The Federal Trade Commission has adopted regulations regarding the collection and use of personal identifying information obtained from children under 13 years of age. Bills proposed in Congress would expand online privacy protections already provided to adults. Moreover, proposed legislation in the U.S. and existing laws in other countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for collection and use of personal information, and provide users with the ability to access, correct and delete personal information stored by companies. These data protection regulations and enforcement efforts may restrict our ability to collect or transfer demographic and personal information from users, which could be costly or harm our marketing efforts. Further, any violation of domestic or foreign or domestic privacy or data protection laws and regulations, including the national do-not-call list, may subject us to fines, penalties and damages, which could decrease our revenue and profitability.

The security risks of e-commerce may discourage customers from purchasing goods from us.

In order for the e-commerce market to be successful, we and other market participants must be able to transmit confidential information securely over public networks. Third parties may have the technology or know-how to breach the security of customer transaction data. Any breach could cause customers to lose confidence in the security of our websites and choose not to purchase from our websites. If someone is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations. Concerns about the security and privacy of transactions over the Internet could inhibit the growth of Internet usage and e-commerce. Our security measures may not effectively prohibit others from obtaining improper access to our information. Any security breach could expose us to risks of loss, litigation and liability and could seriously damage our reputation and disrupt our operations.

Credit card fraud could decrease our revenue and profitability.

We do not carry insurance against the risk of credit card fraud, so the failure to adequately control fraudulent credit card transactions could reduce our revenues or increase our operating costs. We may in the future suffer losses as a result of orders placed with fraudulent credit card data even though the associated financial institution approved payment of the orders. Under current credit card practices, we may be liable for fraudulent credit card transactions. If we are unable to detect or control credit card fraud, or if credit card companies require more burdensome terms or refuse to accept credit card charges from us, our revenue and profitability could decrease.

Our facilities and systems are vulnerable to natural disasters or other catastrophic events.

Our headquarters, customer service center and the majority of our infrastructure, including computer servers, are located near Los Angeles, California in an area that is susceptible to earthquakes and other natural disasters. Our distribution facilities, which are located in Memphis, Tennessee and Irvine, California, house the product inventory from which a substantial majority of our orders are shipped, and are also in areas that are susceptible to natural disasters and extreme weather conditions such as earthquakes, fire, floods and major storms. A natural disaster or other catastrophic event, such as an earthquake, fire, flood, severe storm, break-in, terrorist attack or other comparable events in the areas in which we operate could cause interruptions or delays in our business and loss of data or render us unable to accept and fulfill customer orders in a timely manner, or at all. Our systems, including our management information systems, websites and telephone system, are not fully redundant, and we do not have redundant geographic locations or earthquake insurance. Further, California periodically experiences power outages as a result of insufficient electricity supplies. These outages may recur in the future and could disrupt our operations. We currently have no formal disaster recovery plan and our business interruption insurance may not adequately compensate us for losses that may occur.

We rely on independent shipping companies to deliver the products we sell.

We rely upon third party carriers, especially Federal Express and UPS, for timely delivery of our product shipments. As a result, we are subject to carrier disruptions and increased costs due to factors that are beyond our control, including employee strikes, inclement weather and increased fuel costs. Any failure to deliver products to our customers in a timely and accurate manner may damage our reputation and brand and could cause us to lose customers. We do not have a written long-term agreement with any of these third party carriers, and we cannot be sure that these relationships will continue on terms favorable to us, if at all. If our relationship with any of these third party carriers is terminated or impaired, or if any of these third parties are unable to deliver products for us, we would be required to use alternative carriers for the shipment of products to our customers. We may be unable to engage alternative carriers on a timely basis or on terms favorable to us, if at all. Potential adverse consequences include:

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reduced visibility of order status and package tracking;

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delays in order processing and product delivery;

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increased cost of delivery, resulting in reduced margins; and

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reduced shipment quality, which may result in damaged products and customer dissatisfaction.

Furthermore, shipping costs represent a significant operational expense for us. Any future increases in shipping rates could have a material adverse effect on our business, financial condition and results of operations.

We may not be able to compete successfully against existing or future competitors, which include some of our largest vendors.

The business of direct marketing of computer hardware, software, peripherals and electronics is highly competitive, based primarily on price, product availability, speed and accuracy of delivery, effectiveness of sales and marketing programs, credit availability, ability to tailor specific solutions to customer needs, quality and breadth of product lines and services, and availability of technical or product information. We compete with other direct marketers, including CDW, Insight Enterprises, and PC Connection. In addition, we compete with computer retail stores and resellers, including superstores such as Best Buy and CompUSA, certain hardware and software vendors such as Apple and Dell Computer that sell or are increasing sales directly to end users, online resellers such as Amazon.com, Newegg.com and TigerDirect.com, government resellers such as GTSI and CDWG, software only resellers such as Soft Choice and Software House International and other direct marketers and value added resellers of hardware, software and computer-related and electronic products. In the direct marketing and Internet retail industries, barriers to entry are relatively low and the risk of new competitors entering the market is high. Certain of our existing competitors have substantially greater financial resources than we have. There can be no assurance that we will be able to continue to compete effectively against existing competitors, consolidations of competitors or new competitors that may enter the market.

Furthermore, the manner in which our products and services are distributed and sold is changing, and new methods of sale and distribution have emerged and serve an increasingly large portion of the market. Computer hardware and software vendors have sold, and may intensify their efforts to sell, their products directly to end users. From time to time, certain vendors, including Apple and HP, have instituted programs for the direct sale of large quantities of hardware and software to certain large business accounts. These types of programs may continue to be developed and used by various vendors. Vendors also may attempt to increase the volume of software products distributed electronically to end users’ personal computers. Any of these competitive programs, if successful, could have a material adverse effect on our business, financial condition and results of operations.

Our success is tied to the continued use of the Internet and the adequacy of the Internet infrastructure.

The level of sales generated from our websites, both in absolute terms and as a percentage of our net sales, has increased in recent years in part because of the growing use and acceptance of the Internet by end-users. The growth in Internet usage is a relatively recent development, and no assurance can be made that the Internet will continue to develop or that a sufficiently broad base of consumers will adopt and continue to use the Internet and other online services as a medium of commerce. Continued growth of our Internet sales is dependent on potential customers using the Internet in addition to traditional means of commerce to purchase products. Widespread use of the Internet could decline as a result of disruptions, computer viruses or other damage to Internet servers or users’ computers. If consumer use of the Internet to purchase products does not continue, our business, financial condition and results of operations could be adversely affected.

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

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 political conditions.

We are exposed to the risks of business and other conditions in the Asia Pacific region.

All or portions of certain of the products we sell are produced, or have major components produced, in the Asia Pacific region. We engage in U.S. dollar denominated transactions with U.S. divisions and subsidiaries of companies located in that region as well. As a result, we may be indirectly affected by risks associated with international events, including economic and labor conditions, political instability, tariffs and taxes, availability of products, natural disasters and currency fluctuations in the U.S. dollar versus the regional currencies. In the past, countries in the Asia Pacific region have experienced volatility in their currency, banking and equity markets. Future volatility could adversely affect the supply and price of the products we sell and their components and ultimately, our results of operations.

In the third quarter of 2005, we opened an office in the Philippines in connection with our cost reduction initiatives, and we may increase these and other offshore operations in the future. Establishing offshore operations may entail considerable expense before we realize cost savings, if any, from these initiatives. Our limited operating history in the Philippines, as well as the risks associated with doing business overseas and international events, could prevent us from realizing the expected benefits from our Philippines operations. For example, a national state of emergency was temporarily in effect in the Philippines in early 2006 as a result of political unrest. We could be subject to similar risks and uncertainties, particularly if and to the extent we increase or establish new offshore operations, in the Philippines or elsewhere in the future.

We are subject to risks associated with the evolution of, and consolidation within, our industry.

The personal computer industry has undergone significant change in the past several years. In addition, many new, cost-effective channels of distribution have developed in the industry, such as the Internet, computer superstores, consumer electronic and office supply superstores, national direct marketers and mass merchants. Many computer resellers are consolidating operations and acquiring or merging with other resellers and/or direct marketers to achieve economies of scale and increased efficiency. The current industry reconfiguration and the trend towards consolidation could cause the industry to become even more competitive, further increase pricing pressures and make it more difficult for us to maintain our operating margins or to increase or maintain the same level of net sales or gross profit. Declining prices, resulting in part from technological changes, may require us to sell a greater number of products to achieve the same level of net sales and gross profit. Such a trend could make it more difficult for us to continue to increase our net sales and earnings growth. In addition, growth in the personal computer market has slowed. If the growth rate of the personal computer market were to further decrease, our business, financial condition and operating results could be materially adversely affected.

Our success is in part dependent on the accuracy and proper utilization of our management information systems.

Our ability to analyze data derived from our management information systems, including our telephone system, to increase product promotions, manage inventory and accounts receivable collections, to purchase, sell and ship products efficiently and on a timely basis and to maintain cost-efficient operations, is dependent upon the quality and utilization of the information generated by our management information systems. We regularly upgrade our management information system hardware and software to better meet the information requirements of our users, and believe that to remain competitive, it will be necessary for us to upgrade our management information systems on a regular basis in the future. We currently operate our management information systems using an HP3000 Enterprise System. HP has indicated that it will support this system until December 2008, by which time we expect that we will need to seek third party support for our HP3000 Enterprise System or upgrade to other management information systems hardware and software. In addition to the costs associated with such upgrades, the transition to and implementation of new or upgraded hardware or software systems can result in system delays or failures which could impair our ability to receive, process, ship and bill for orders in a timely manner. We do not currently have a redundant or back-up telephone system, nor do we have complete redundancy for our management information systems. Any interruption in our management information systems, including those caused by natural disasters, could have a material adverse effect on our business, financial condition and results of operations.

If we are unable to provide satisfactory customer service, we could lose customers or fail to attract new customers.

Our ability to provide satisfactory levels of customer service depends, to a large degree, on the efficient and uninterrupted operation of our customer service operations. Any material disruption or slowdown in our order processing systems resulting from labor disputes, telephone or Internet failures, power or service outages, natural disasters or other events could make it difficult or impossible to provide adequate customer service and support. Furthermore, we may be unable to attract and retain adequate numbers of competent customer service representatives and relationship managers for our business customers, each of which is essential in creating a favorable interactive customer experience. If we are unable to continually provide adequate staffing and training for our customer service operations, our reputation could be seriously harmed and we could lose customers or fail to attract new customers. In addition, if our e-mail and telephone call volumes exceed our present system capacities, we could experience delays in placing orders, responding to customer inquiries and addressing customer concerns. Because our success depends largely on keeping our customers satisfied, any failure to provide high levels of customer service would likely impair our reputation and decrease our revenues.

Our stock price may be volatile.

We believe that certain factors, such as sales of our common stock into the market by existing stockholders, fluctuations in our quarterly operating results, changes in market conditions affecting stocks of computer hardware and software manufacturers and resellers generally and companies in the Internet and e-commerce industries in particular, could cause the market price of our common stock to fluctuate substantially. Other factors that could affect our stock price include,but are not limited to, the following:

•

failure to meet investors’ expectations regarding our operating performance;

•

changes in securities analysts’ recommendations or estimates of our financial performance;

•

publication of research reports by analysts;

•

changes in market valuations of similar companies;

•

announcements by us or our competitors of significant contracts, acquisitions, commercial relationships, joint ventures or capital commitments;

•

actual or anticipated fluctuations in our operating results;

•

litigation developments; and

•

general market conditions or other economic factors unrelated to our performance.

The stock market in general, and the stocks of computer and software resellers, and companies in the Internet and electronic commerce industries in particular, and other technology or related stocks, have in the past experienced extreme price and volume fluctuations which have been unrelated to corporate operating performance. Such market volatility may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a public company’s securities, securities class action litigation has often been instituted against that company. Such litigation,if asserted against us, could result in substantial costs to us and cause a likely diversion of our management’s attention from the operations of our company.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the annual meeting of the stockholders held on August 11, 2006, the following matters were submitted to a vote of the stockholders of PC Mall, Inc.:

1. The reelection as directors of Frank F. Khulusi, Thomas A. Maloof, Ronald B. Reck and Paul C. Heeschen, all of whom were reelected at the annual meeting. Each of the directors received the following votes:


	FOR	WITHHELD
Frank F. Khulusi	8,786,686	3,032,857
Thomas A. Maloof	11,538,891	280,652
Ronald B. Reck	11,438,198	381,345
Paul C. Heeschen	11,437,948	381,595

2. The ratification of the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2006.


	FOR	AGAINST	ABSTENTIONS
Appointment of Independent Registered Public Accounting Firm	11,581,301	213,512	24,730

ITEM 6.

EXHIBITS


Exhibit Number		Description
10.1		Asset Purchase Agreement, dated as of September 7, 2006, by and among a wholly-owned subsidiary of PC Mall Gov, Inc. GMRI and the shareholders of GMRI(incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K of PC Mall, Inc. (File No. 0-25790) filed with the Commission on September 12, 2006)

10.2		Renewal Letter for lease of property in Memphis, Tennessee, entered into on October 2, 2006 (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K of PC Mall, Inc. (File No. 0-25790) filed with the Commission on October 6, 2006)

31.1		Certification of the Chief Executive Officer of the Registrant pursuant to Exchange Act Rule 13a-14(a)

31.2		Certification of the Chief Financial Officer of the Registrant pursuant to Exchange Act Rule 13a-14(a)

32.1		Certification of the Chief Executive Officer of Registrant furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of the Chief Financial Officer of Registrant furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

***

PC MALL, INC.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	PC MALL, INC.
	(Registrant)

Date: November 3, 2006	By:	/s/ Theodore R. Sanders
		Theodore R. Sanders
		Chief Financial Officer

		(Duly Authorized Officer of the Registrant and Principal Financial Officer)

PC MALL, INC.

EXHIBIT INDEX


Exhibit Number		Description
10.1		Asset Purchase Agreement, dated as of September 7, 2006, by and among a wholly-owned subsidiary of PC Mall Gov, Inc. GMRI and the shareholders of GMRI(incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K of PC Mall, Inc. (File No. 0-25790) filed with the Commission on September 12, 2006)

10.2		Renewal Letter for lease of property in Memphis, Tennessee, entered into on October 2, 2006 (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K of PC Mall, Inc. (File No. 0-25790) filed with the Commission on October 6, 2006)

31.1		Certification of the Chief Executive Officer of the Registrant pursuant to Exchange Act Rule 13a-14(a)

31.2		Certification of the Chief Financial Officer of the Registrant pursuant to Exchange Act Rule 13a-14(a)

32.1		Certification of the Chief Executive Officer of Registrant furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of the Chief Financial Officer of Registrant furnished pursuant to 18 U.S.C. 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. junior Good

Pcm (PCMI) Inactive 10-Q2006 Q3 Quarterly report

Content analysis