- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
------------
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE COMMISSION
Commission File Number 0-23827
------------
PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
Delaware 02-0513618
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Rt. 101A, 730 Milford Road
Merrimack, New Hampshire 03054
(Address of principal executive offices) (Zip Code)
------------
(603) 423-2000
(Registrant's telephone number, including area code)
------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting and non-voting stock held by non-
affiliates of the Registrant, based upon the closing price of the Registrant's
Common Stock as reported on the NASDAQ National Market on March 22, 2001, was
$60,260,881. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for the purposes of this
calculation, this classification is not to be interpreted as an admission of
such status.
The number of outstanding shares of the Registrant's Common Stock on March
22, 2001 was 24,418,860.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2001 Annual Meeting of
Shareholders for the fiscal year ended December 31, 2000, which is to be filed
within 120 days of the end of the Company's fiscal year, are incorporated by
reference into Part III of this Form 10-K. The incorporation by reference
herein of portions of the Proxy Statement shall not be deemed to specifically
incorporate by reference the information referred to in Item 402(a) (8) of
Regulation S-K.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PC CONNECTION, INC. AND SUBSIDIARIES
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Business............................................................................... 1
ITEM 2. Properties............................................................................. 11
ITEM 3. Legal Proceedings...................................................................... 11
ITEM 4. Submission of Matters to a Vote of Security Holders.................................... 11
PART II
ITEM 5. Market for the Registrant's Common Stock and Related Stockholder Matters............... 13
ITEM 6. Selected Financial and Operating Data.................................................. 13
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 16
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.............................. 26
ITEM 8. Consolidated Financial Statements and Supplementary Data............................... 27
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 27
PART III
ITEM 10. Directors and Executive Officers of the Registrant..................................... 27
ITEM 11. Executive Compensation................................................................. 27
ITEM 12. Security Ownership of Certain Beneficial Owners and Management......................... 27
ITEM 13. Certain Relationships and Related Transactions......................................... 27
PART IV
ITEM 14. Exhibits, Consolidated Financial Statements, and Reports on Form 8-K................... 28
SIGNATURES...................................................................................... 32
ii
PART I
ITEM 1. Business
This section contains forward-looking statements based on management's
current expectations, estimates and projections about the industry in which we
operate, management's beliefs and certain assumptions made by management. All
statements, trends, analyses and other information contained in this report
relative to trends in net sales, gross margin and anticipated expense levels,
as well as other statements, including words such as "anticipate", "believe",
"plan", "estimate" and "intend" and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those anticipated
or expressed in such statements. Potential risks and uncertainties include,
among others, those set forth under the caption "Factors That May Affect Future
Results and Financial Condition" included in Item 7 "Management's Discussion
and Analysis of Financial Condition and Results of Operations". Particular
attention should be paid to the cautionary statements involving the industry's
rapid technological change and exposure to inventory obsolescence, availability
and allocations of goods, reliance on vendor support and relationships,
competitive risks, pricing risks and economic risks. Except as required by law,
the Company undertakes no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise. Readers,
however, should carefully review the factors set forth in other reports or
documents that the Company files from time to time with the Securities and
Exchange Commission.
General
PC Connection, Inc. and subsidiaries (together, referred to below as "PC
Connection", or "the Company") is a direct marketer of information technology
products and solutions, including brand-name personal computers and related
peripherals, software, accessories and networking products. The Company markets
its products principally to small and medium-sized businesses, which are
referred to as SMBs, comprised of 20 to 1,000 employees. The Company also
markets its products to larger businesses, governmental and educational
organizations and consumers. The Company sells its products through a
combination of targeted direct mail catalogs, outbound telemarketing, its
Internet web site and advertisements on the Internet and in selected computer
magazines. The Company offers a broad selection of approximately 100,000
products targeted for business use at competitive prices, including products
from Compaq, Hewlett-Packard, Toshiba, IBM, Microsoft, Sony, EMC, Canon, Iomega
and Apple. Net sales of Microsoft Windows or MS-DOS based personal computers,
or PCs, and compatible products were approximately 90% of net sales in 2000.
The Company's most frequently ordered products are carried in inventory and are
typically shipped to customers the same day that the order is received.
Since its founding in 1982, PC Connection has served its customers' needs by
providing innovative, reliable and timely service and technical support, and by
offering more than 100,000 brand-name products through its technically-trained
sales and support teams. The effectiveness of this strategy is reflected by the
recognition the Company continues to receive. For the year 2000, PC Connection
was ranked number 7 in Business Week's annual listing of the world's leading
information technology companies, and was listed on the Forbes Platinum 400
List for the first time. Yahoo! Internet Life recently named PC Connection,
"the best place to shop for computers," and listed the Company's web sites;
pcconnection.com and macconnection.com, among the 100 Best Sites on the
Internet. PC Connection was listed as one of the 100 most influential companies
in the computer industry in PC Magazine's special issue titled, "100 Technology
Companies That Are Changing the World." In addition, PC Connection has won PC
World magazine's prestigious "World Class Award" nine times over the past
eleven years, including 2000.
The Company believes that its consistent customer focus has also resulted in
the development of strong brand name recognition and a broad and loyal customer
base. At December 31, 2000, the Company's mailing list consisted of
approximately 3,117,000 customers and potential customers, of which
approximately 626,000 had purchased products from the Company within the last
twelve months. Approximately 79% of its net sales in the year ended December
31, 2000 were made to customers who had previously purchased products from the
1
Company. Management believes that the Company also has strong relationships
with vendors, resulting in favorable product allocations and marketing
assistance.
The Company's fastest growing customer segments include businesses which are
investing aggressively in web-based marketing programs and other high growth
organizations which are increasingly dependent on distributed data and
communication networks. Management believes that the Company's pioneering
Everything Overnight(R) program has set it apart as the premier rapid response
supplier of information technology products and solutions to the middle market.
Enterprise networking infrastructure products, such as PC-based servers,
routers and switches, were among the Company's fastest growing product
categories in 2000, increasing by more than 102% in 2000 compared to 1999.
Sales of enterprise networking products accounted for 17.4% of total net sales
in 2000, up from 11.6% of total net sales in 1999. Over the next few years, the
Company anticipates that an increasing share of its revenues will come from the
sale of enterprise networking infrastructure products and services, including
network-based storage solutions, versus the current sales concentration in
desktop and portable computers.
During 2000, the Company invested heavily in training, technical
certification and other programs to support the rapidly growing demand from its
customers for networking and related products. The Company launched its
proprietary Network Solutions Consultant program in January 2000.
The Company focuses its business-to-business marketing efforts primarily on
SMBs, a rapidly growing sector of the market that the Company believes is
particularly receptive to purchases from direct marketers. In order to service
this growing part of its business more effectively, the Company increased the
number of its outbound telemarketing account managers from 345 at December 31,
1999 to 575 at December 31, 2000. This growth includes 327 new account managers
with fewer than 12 months of outbound telemarketing experience with the
Company.
The Company's two major catalogs are PC Connection(R), focused on PCs and
compatible products, and MacConnection(R), focused on Apple Macintosh personal
computers, known as "Macs", and compatible products. With colorful
illustrations, concise product descriptions, relevant technical information and
toll-free telephone numbers for ordering, the Company's catalogs are recognized
as a leading source for personal computer hardware, software and other related
products. The Company distributed approximately 45 million catalogs during the
year ended December 31, 2000.
The Company also markets its products and services through its Internet web
sites, www.pcconnection.com and www.macconnection.com. The Company's web sites
provide customers and prospective customers with product information and enable
customers to place electronic orders for products. Internet sales processed
directly online during the fourth quarter of 2000 were $30.6 million, or 8.9%
of that quarter's net sales. Online sales in the fourth quarter of 2000
increased 55.3% over the comparable quarter in 1999. For the fiscal year 2000,
these sales were $113.0 million, or 7.8% of net sales, compared to 5.6% in
1999. These results represent a 86.5% increase in annual Internet sales over
1999.
The Company believes that the reason its electronic commerce business is
growing so rapidly is that it offers customers the advanced tools they need to
quickly make educated purchasing decisions. Working closely with vendors, the
Company believes that it is able to provide one of the broadest, leading-edge
technology selections in the industry. By using its merchandising expertise,
catalog mailings and established infrastructure, the Company has built a
profitable Internet business and one that complements all its other sales
channels.
For the Company the web fundamentally supports three key business
initiatives:
. Providing customer choice--The Company has built its business on the
premise that its customers should be able to choose how they interact
with the Company, be it by mail, telephone, fax, e-mail or over the web.
. Lowering transactions costs--The Company's web site tools, including
robust product search features, Smart Selectors(R), Internet Business
Accounts(R) and special interest pages, allow customers to
2
quickly and easily find information about products of interest to them.
If they still have questions, the Company's Telesales Representatives
and Outbound Account Managers are just a phone call away. Such phone
calls are typically shorter and have higher close rates than calls from
customers who have not first visited our web sites.
. Leveraging the time of experienced Account Managers--The Company's
investments in technology-based sales and service programs demonstrate
the power of technology at its best, leveraging its Account Managers to
do what they do best: building and maintaining relationships with
customers and helping them to solve their business problems.
Formation of Holding Company
On January 1, 2000, the Company formed a new holding company structure to
support PC Connection's future growth and plans to expand its current business
lines through internal growth and potential acquisitions.
Outstanding shares of common stock representing interests in PC Connection
prior to the holding company formation were converted into shares of the new
holding company on a one-for-one basis through a non-taxable transaction.
Common stock shares of the new holding company trade on the Nasdaq National
Market under the symbol, "PCCC", the same exchange and symbol used by the
predecessor company. The new shares hold the same voting power that shares of
the predecessor held. No additional capital stock was issued as part of the
transaction. The directors and officers of the predecessor company serve as
the directors and officers of the new holding company.
Industry Background
The SMB marketplace is very large including approximately 7.4 million small
businesses with fewer than 100 employees and approximately 157,000 medium
businesses with 100 to 999 employees. SMB's annually spend approximately $150
billion on information technology (IT) products and services with
approximately $103 billion spent in product categories addressed by the
Company's product and services offerings. These estimates exclude IT spending
by consumers, home-based businesses and educational, not-for-profit and
governmental organizations.
The Company believes that sales of personal computers and related products
have increased principally as a result of:
. technological advances leading to significant improvements in
performance, functionality and ease of use;
. lower prices and improved price/performance driven by intense
competition among manufacturers, retailers and resellers;
. increased dependence upon PCs by businesses, educational institutions
and governments;
. the emergence of industry standards and component commonality;
. upgrade of electronic commerce capabilities.
The Company believes that the direct marketing channel will continue to
grow faster than the overall industry due primarily to increased user
familiarity with PCs, coupled with the emergence of industry standards and
component commonality, broader product offerings, lower prices and greater
purchasing convenience that direct marketers generally provide over
traditional retail stores and local dealers.
Users of personal computers range from large corporate entities focused on
business applications to individual consumers focused primarily on personal
productivity, education and entertainment applications.
3
Historically, large corporate resellers have served the needs of FORTUNE 1000
companies, and retailers have competed to serve the consumer market. SMBs, the
Company's core target customers, are being served by a wide range of suppliers,
including direct marketers, large retailers, small, independent, value-added
resellers ("VARs"), and local dealerships. The Company believes that the direct
field sales model used by large resellers is not an efficient method of
reaching SMBs, and that VARs, local dealerships and retailers are unable to
match the high level of customer service, extensive selection of products and
low prices afforded to SMBs by direct marketers. Intense competition for market
share has led manufacturers of PCs and related products to use all available
channels to distribute products, including direct marketers. Although certain
manufacturers that have traditionally used resellers to distribute their
products have established or attempted to establish their own direct marketing
operations, including sales through the Internet, the Company believes these
manufacturers will continue to provide the Company and other third-party direct
marketers favorable product allocations and marketing support.
The Company believes new entrants to the direct marketing channel must
overcome a number of obstacles, including:
. the time and resources required to build a meaningful customer base,
quality and responsiveness for cost-effective circulation;
. costs of developing the information and operating infrastructure
required by direct marketers;
. the advantages enjoyed by larger and more established competitors in
terms of purchasing and operating efficiencies;
. the difficulty of building relationships with manufacturers to achieve
favorable product allocations and attractive pricing terms; and
. the difficulty of identifying and recruiting management personnel with
significant direct marketing experience in the industry.
Business Strategies
The Company's objective is to become the leading rapid response supplier of
information technology products and solutions, including personal computers and
related products and services, to the Company's customers. The key elements of
the Company's business strategies include:
. The Company provides award-winning customer service before, during and
after the sale. The Company believes that it has earned a reputation for
providing superior customer service by consistently focusing on its
customer needs. The Company has won PC World's "World Class Award for
Best Mail Order Company" in nine out of the last eleven years, including
a 2000 award for "Best Online/Mail Order Catalog Company". The Company
delivers value to its customers through high quality service and
technical support provided by its knowledgeable, well-trained personnel.
The Company has efficient and innovative delivery programs. It also
offers its customers competitive prices and reasonable return policies.
. The Company maintains a strong brand name and customer awareness. Since
its founding in 1982, the Company has built a strong brand name and
customer awareness. In July 1999, the Company was the only direct
reseller included in the "100 Most Influential Companies in the Computer
Industry" by PC Magazine. In 1998 and 1997, the Company was one of only
two direct resellers included in the listing. The Company's mailing list
includes approximately 3,117,000 names, of which approximately 626,000
have purchased products from the Company during the last 12 months. In
1999, PC Connection ranked among the "Top 100 Hottest Companies on the
Internet" by Business 2.0 Magazine.
. The Company offers a broad product selection at competitive prices. The
Company offers its customers a wide assortment of computing, networking,
data storage and related products at
4
competitive prices. The Company's merchandising programs feature
products that provide customers with aggressive price and performance
and the convenience of one-stop shopping for their personal computer and
related needs.
. The Company has long-standing vendor relationships. The Company has a
history of strong relationships with vendors, and it was among the first
direct marketers qualified by manufacturers to market systems to end-
users. The Company provides its vendors with both information concerning
customer preferences and an efficient channel for the advertising and
distribution of their products.
Growth Strategies
The Company's growth strategies are to expand and increase penetration of
its existing customer base and to broaden its product offerings. The key
elements of the Company's growth strategies include the following:
. Increase outbound telemarketing. The Company plans to continue to
increase the number of corporate outbound account managers and assign
them to a greater number of customers. Outbound account managers focus
exclusively on serving specifically assigned customers and seek to
develop a close relationship with those customers by identifying and
responding to their needs for computing, networking, data storage and
related products.
. Expand product offerings. The Company continually evaluates information
technology products focused on business users, adding new products as
they become available or in response to customer demand. The Company
works closely with vendors to identify and source first-to-market
product offerings at aggressive prices and believes that the expansion
of its corporate outbound marketing program will enhance its access to
such product offerings. During 2000 and early 2001, PC Connection became
the first direct marketer authorized by EMC Corporation to sell EMC's
CLARiiON line of mid-range storage area network (SAN) and network
attached storage (NAS) data storage products. EMC is currently the world
leader in the sale of networked storage solutions.
. Target specific customer populations. Through targeted mailings, the
Company seeks to expand the number of active customers and generate
additional sales from its existing customers. The Company has developed
specialty catalogs, as well as standard catalogs with special cover
pages, featuring product offerings designed to address the needs of
specific customer populations, including new product inserts targeted to
purchasers of graphics, server and networking products.
. Expand electronic commerce channel. The Company's Internet web-based
catalog provides detailed product descriptions, product search
capabilities and on-line order processing. The Company has seen a rapid
increase in on-line sales and believes that an increasing number of
customers and potential new customers will shop electronically in the
future. Therefore, the Company plans to further improve on-line sales
capabilities, customer service and product information and customer
support available on its Internet web site. During 2000, the number of
customers utilizing the Company's proprietary Internet Business
Accounts(R) grew six-fold to over 15,500 at December 31, 2000.
. Pursue strategic acquisitions and alliances. The Company completed its
first acquisition in June 1999 of ComTeq Federal, Inc. ("ComTeq").
ComTeq, based in Rockville, Maryland, is a specialty reseller focused on
agencies of the federal government. The Company acquired the Merisel
Americas, Inc. call center in Marlborough, Massachusetts in January
2000. Through its acquisition program, the Company seeks to acquire new
customers, strengthen its product offerings, add management talent and
produce operating results, which are accretive to its core business
earnings.
Service and Support
Since the Company's founding in 1982, its primary objective has been to
provide products that meet the demands and needs of customers and to
supplement those products with up-to-date product information and excellent
customer service and support. The Company believes that offering its customers
superior value,
5
through a combination of product knowledge, consistent and reliable service and
leading products at competitive prices, differentiates it from other direct
marketers and establishes the foundation for developing a broad and loyal
customer base. The Company has introduced programs such as Toll-Free Technical
Support in 1982, the Everything Overnight(R) delivery program in 1988, Money
Back Guarantees in 1989, One-Minute Mail Order(R) in 1991, On-line Superstore
in 1997, and Your Brands, Your Way, Next Day(R) in 1998.
The Company invests in training programs for its service and support
personnel, with an emphasis on putting customer needs and service first.
Customer service representatives are available 24 hours a day, seven days a
week to handle orders, product information, general inquiries and technical
support questions.
The Company provides toll-free technical support from 9 a.m. through 5 p.m.,
Eastern Standard Time, Monday through Friday. Product support technicians
assist callers with questions concerning compatibility, installation,
determination of defects and more difficult questions relating to product use.
The product support technicians authorize customers to return defective or
incompatible products to either the manufacturer or to the Company for warranty
service. In-house technicians perform both warranty and non-warranty repair on
most major systems and hardware products.
Using its customized information system, the Company sends its customer
orders to its distribution center for processing immediately after a customer
receives credit approval. Through its Everything Overnight(R) service, it
guarantees that all orders for in-stock merchandise accepted up until 2:00 a.m.
(until midnight on most custom-configured systems) can be shipped for overnight
delivery via Airborne Express. The Company also configures approximately 20% of
the computer systems it sells. Configuration typically consists of the
installation of memory, accessories and/or software.
Marketing And Sales
The Company sells products through its direct marketing channel, primarily
to SMBs. The Company seeks to be the primary supplier of computing, networking,
data storage and related products to its existing customers and to expand its
customer base. The Company uses multiple marketing approaches to reach existing
and prospective customers, including:
. outbound telemarketing;
. catalogs and inbound telesales;
. Web and print media advertising; and
. marketing programs targeted to specific customer populations.
All of its marketing approaches emphasize its broad product offerings, fast
delivery, customer support, competitive pricing and multiple payment options.
The Company believes that its ability to establish and maintain long-term
customer relationships and to encourage repeat purchases is largely dependent
on the strength of its telemarketing personnel and programs. Because customers'
primary contact with the Company is through its telemarketers, the Company is
committed to maintaining a qualified, knowledgeable and motivated sales staff
with its principal focus on customer service.
6
The following table sets forth the Company's percentage of net sales by
sales channel:
Years Ended
December 31,
----------------
2000 1999 1998
---- ---- ----
Sales Channel
Corporate Outbound............................................ 76% 65% 53%
Inbound Telesales............................................. 16 29 43
On-Line Internet.............................................. 8 6 4
--- --- ---
Total....................................................... 100% 100% 100%
=== === ===
Outbound Telemarketing. The Company seeks to build loyal relationships with
its potential high-volume customers by assigning them to individual account
managers. The Company believes that customers respond favorably to a one-on-one
relationship with personalized, well-trained account managers. Once
established, these one-on-one relationships are maintained and enhanced through
frequent telecommunications, targeted catalogs and other marketing materials
designed to meet each customer's specific computing needs.
Account managers focus exclusively on their managed accounts and on outbound
sales calls to prospective customers. The Company generally recruits account
managers from other sales organizations and from its inbound telemarketing
staff. All account managers must successfully complete a two-month training
program, which includes instruction in the Company's product offerings and
order management systems, as well as selling skills and account management.
Thereafter, new account managers are assigned to sales teams where they receive
intensive coaching and supervision by experienced supervisors, and periodic
refresher training from the sales training staff. Additional training and
product education programs are provided continuously through programs supported
by the Company's vendors. The Company pays its account managers a base annual
salary plus incentive compensation. Incentive compensation is tied to sales
volume and gross profit dollar goals by the individual account manager. Account
managers historically have significantly increased productivity after
approximately 12 months of training and experience. At December 31, 2000, the
Company employed 575 account managers, including 327 with fewer than 12 months
of outbound telemarketing experience with the Company.
Catalogs and Inbound Telesales. The Company's two principal catalogs are PC
Connection(R) for the PC market and MacConnection(R) for the Mac market. The
Company publishes twelve editions of each of these catalogs annually. The
Company distributes catalogs to purchasers on its in-house mailing list as well
as to other prospective customers. The Company sends its two principal catalogs
to its best customers twice each month. The initial mailing each month, labeled
an "early edition," is sent simultaneously to the best customers throughout the
United States and features special offers, such as first-to-market product
offerings, highlighted on the cover. The Company also includes a catalog with
each order shipped.
In addition, the Company mails specialty catalogs or customized versions of
its catalogs to selected customers. The Company distributes specialty catalogs
to educational and governmental customers and prospects on a periodic basis.
The Company also distributes its monthly catalogs customized with special
covers and inserts, offering a wider assortment of special offers on products
in specific areas, such as graphics, server/netcom and mobile computing, or for
specific customers, such as developers. These customized catalogs are
distributed to targeted customers included in the Company's customer database
using past identification or purchase history, as well as to outside mailing
lists.
Each catalog is printed with full-color photographs, detailed product
descriptions and manufacturer specifications. The catalogs are primarily
created by in-house designers and production artists on a computer-based
desktop publishing system. The in-house preparation of most portions of the
catalog expedites the Company's production process and provides it with greater
flexibility and creativity in catalog production by allowing for last-minute
changes in pricing and format. Overall, such in-house preparation results in
significant
7
cost savings to the Company. After completion of the design and preparation,
the Company outsources the catalogs to commercial printers for printing.
The Company's inbound sales representatives answer customer telephone calls
generated by its catalog, magazine and other advertising programs. These
representatives also assist customers in making purchasing decisions, process
product orders and respond to customer inquiries on order status, product
pricing and availability. The Company provides training to its inbound
telemarketing personnel and provides incentive compensation based upon sales
productivity. The Company has a flexible staffing model which allows it to
maintain excellent customer service during periods of peak demand while
maintaining an efficient cost structure. The Company regularly monitors calls
for quality assurance purposes and has been a pioneer in using caller
identification for the instant retrieval of customer records. Using proprietary
information systems, sales representatives can quickly access customer records
which detail purchase history and billing and shipping information, expediting
the ordering process. In addition to receiving orders through its toll-free
numbers, orders are also received via fax, mail and electronic mail.
Advertising. The Company has historically advertised in selected personal
computer and trade magazines, such as PC Magazine, PC World and Macworld. These
advertisements provide potential customers with product descriptions,
manufacturers' specifications and pricing information, while emphasizing the
Company's service and support features. Additionally, the PC Connection(R) logo
and telephone numbers are included in promotions by selected manufacturers.
www.pcconnection.com. In November 1996, the Company launched an Internet web
site, which includes a complete product catalog. In July 1997, the Company
began accepting electronic orders through its Internet web site. The Company
also provides updated information for over 23,000 items and on screen images
available for over 6,000 items. The Company offers, and continuously updates,
selected product offerings and other special buys. The Company believes that in
the future its Internet web site will be an important sales source and
communication tool for improving customer service.
Specialty Marketing. The Company's specialty marketing activities include
direct mail, other inbound and outbound telemarketing services, bulletin board
services, "fax on demand" services, package inserts, fax broadcasts and
electronic mail. The Company also markets call-answering and fulfillment
services to certain of its product vendors.
Customers. The Company currently maintains an extensive database of
customers and prospects aggregating approximately 3,117,000 names. During the
year ended December 31, 2000, the Company received orders from approximately
626,000 customers. Approximately 79% of its net sales in the year ended
December 31, 2000 were made to customers who had previously purchased products
from the Company, representing an 11% increase from the prior year.
Products And Merchandising
The Company continuously focuses on expanding the breadth of its product
offerings. The Company currently offers approximately 100,000 computing,
networking, data storage and related products designed for business
applications from over 1,000 manufacturers. The Company offers both PCs and
Macs and related products. In 2000, sales of PCs and related products were
approximately 90% of net sales. The Company selects the products that it sells
based upon their technology and effectiveness, market demand, product features,
quality, price, margins and warranties. As part of its merchandising strategy,
the Company also offers new types of products related to PCs, such as digital
cameras.
8
The following table sets forth the Company's percentage of net sales (in
dollars) of notebook computers, desktop and server computers, storage devices,
software, networking communications, printers, video and monitors, memory,
accessories and other products during the years ended December 31, 2000, 1999
and 1998.
Percentage Of
Net Sales
----------------
Years Ended
December 31,
----------------
2000 1999 1998
---- ---- ----
Notebooks....................................................... 25% 23% 20%
Desktops/Servers................................................ 15 15 15
Storage Devices................................................. 10 10 11
Software........................................................ 10 12 14
Networking Communications....................................... 8 6 6
Printers........................................................ 7 9 8
Video & Monitors................................................ 8 8 8
Memory.......................................................... 4 4 4
Accessories/Other............................................... 13 13 14
--- --- ---
TOTAL..................................................... 100% 100% 100%
=== === ===
The Company offers a limited 30-day money back guarantee for most unopened
products and selected opened products, although selected products are subject
to restocking fees. Substantially all of the products marketed by the Company
are warranted by the manufacturer. The Company generally accepts returns
directly from the customer and then either credits the customer's account or
ships the customer a similar product from its inventory.
Purchasing And Vendor Relations
For the year ended December 31, 2000, the Company purchased approximately
43% of its products directly from manufacturers and the balance from
distributors and aggregators. The majority of products are shipped directly to
the Company's distribution facility in Wilmington, Ohio. During the years ended
December 31, 2000 and 1999, product purchases from Ingram Micro, Inc., the
Company's largest vendor, accounted for approximately 25.6% and 21.7%,
respectively, of its total product purchases. Purchases from Tech Data
Corporation comprised 11.2% and 7.0% of the Company's total purchases in the
years ended December 31, 2000 and 1999, respectively. No other vendor accounted
for more than 10% of the Company's total product purchases. The Company
believes that alternative sources for products obtained from Ingram Micro, Inc.
and Tech Data Corporation are available.
Many product suppliers reimburse the Company for advertisements or other
cooperative marketing programs in the Company's catalogs or advertisements in
personal computer magazines that feature a manufacturer's product.
Reimbursements may be in the form of discounts, advertising allowances and/or
rebates. The Company also receives reimbursements from certain vendors based
upon the volume of purchases or sales of the vendors' products. Historically,
the Company received price consideration and support including price protection
and rebates from its vendors on a majority of the products it sold.
Price protection takes the form of rebates or credits against future
purchases. The Company may participate in end-of-life-cycle and other special
purchases which may not be eligible for price protection.
The Company believes that it has excellent relationships with vendors. The
Company generally pays vendors within stated terms and takes advantage of all
appropriate discounts. The Company believes that because of its volume
purchases it is able to obtain product pricing and terms that are competitive
with those available to other major direct marketers. Although brand names and
individual product offerings are important to its business, the Company
believes that competitive sources of supply are available in substantially all
of the merchandise categories offered.
9
Distribution
At the Company's approximately 205,000 square foot distribution and
fulfillment complex in Wilmington, Ohio, the Company receives and ships
inventory, configures computer systems and processes returned products. Orders
are transmitted electronically from the Company's New Hampshire and
Massachusetts sales facilities to the Wilmington distribution center after
credit approval, where packing documentation is printed automatically and order
fulfillment takes place. Through its Everything Overnight service, the Company
guarantees that all orders for in-stock merchandise accepted up until 2:00 a.m.
Eastern Standard Time (until midnight on custom-configured systems) can be
shipped for overnight delivery via Airborne Express. The Company ships
approximately 62% of its orders through Airborne Express. Upon request, orders
may also be shipped by other common carriers.
The Maryland sales facility of ComTeq Federal primarily places product
orders directly with manufacturers and/or distribution companies for drop
shipment by those manufacturers and/or suppliers directly to ComTeq's
customers. Order status with distributors is tracked on line and in all
circumstances, a confirmation of shipment from manufacturers and/or
distribution companies is received prior to recording revenue.
Management Information Systems
The Company uses management information systems, principally comprised of
applications software running on IBM AS/400 and RS6000 computers and Microsoft
NT-based servers, which the Company has customized for its use. These systems
permit centralized management of key functions, including order taking and
processing, inventory and accounts receivable management, purchasing, sales and
distribution, and the preparation of daily operating control reports on key
aspects of the business. The Company also operates advanced telecommunications
equipment to support its sales and customer service operations. Key elements of
the Company's telecommunications systems are integrated with the Company's
computer systems to provide timely customer information to sales and service
representatives, and to facilitate the preparation of operating and performance
data. The Company believes that its customized information systems enable it to
improve productivity, ship customer orders on a same-day basis, respond quickly
to changes in the Company's industry and provide high levels of customer
service.
The Company's success is dependent in large part on the accuracy and proper
use of its information systems, including its telephone systems, to manage its
inventory and accounts receivable collections, to purchase, sell and ship the
Company's products efficiently and on a timely basis, and to maintain cost-
efficient operations. The Company expects to continually upgrade its
information systems to more effectively manage its operations and customer
database. In 1998, the Company replaced its order management and fulfillment
software with new software and converted its principal computer equipment to
new IBM AS400 platform systems, both of which are better suited to its expected
scale of operations and were designed to be Year 2000 compliant.
Competition
The direct marketing and sale of computing, networking, data storage and
related products is highly competitive. PC Connection competes with other
direct marketers of computers and related products, including CDW Computer
Centers, Inc. and Insight Enterprises, Inc. The Company also competes with:
. certain product manufacturers that sell directly to customers, such as
Dell Computer Corporation and Gateway, Inc. and, more recently, Compaq,
IBM and Apple;
. distributors that sell directly to certain customers, such as MicroAge,
Inc.;
. various cost-plus aggregators, franchisers and national computer
retailers, such as CompUSA, Inc.; and
. companies with more extensive Internet web sites and commercial on-line
networks.
10
Additional competition may arise if other new methods of distribution, such
as broadband electronic software distribution, emerge in the future.
The Company competes not only for customers, but also for favorable product
allocations and cooperative advertising support from product manufacturers.
Several of the Company's competitors are larger and have substantially greater
financial resources.
The Company believes that price, product selection and availability, and
service and support are the most important competitive factors in its industry.
Intellectual Property Rights
The Company's trademarks include PC Connection(R) and MacConnection(R) and
their related logos; Everything Overnight(R), One-Minute Mail Order(R), PC &
Mac Connection(R), Systems Connection(R), The Connection(R), Raccoon
Character(R), Service Connection(TM), Graphics Connection(TM), Memory
Connection(TM), Your Brands, Your Way, Next Day(R), Epiq PC Systems(R) and
Webase(R). The Company intends to use and protect these and its other marks, as
it deems necessary. The Company believes its trademarks and service marks have
significant value and are an important factor in the marketing of its products.
The Company does not maintain a traditional research and development group, but
it works closely with computer product manufacturers and other technology
developers to stay abreast of the latest developments in computing technology,
both with respect to the products it sells and uses.
Employees
As of December 31, 2000, the Company employed 1,654 persons, of whom 806
were engaged in sales related activities, 99 were engaged in providing customer
service and support, 423 were engaged in purchasing, marketing and distribution
related activities, 116 were engaged in the operation and development of
management information systems, and 210 were engaged in administrative and
accounting functions. The Company considers its employee relations to be good.
The Company's employees are not represented by a labor union and the Company
has never experienced a work stoppage since its inception.
ITEM 2. Properties
In November 1997, the Company entered into a fifteen year lease for a new
corporate headquarters and telemarketing center located at Route 101A, 730
Milford Road, Merrimack, New Hampshire 03054-4631, with an affiliated entity,
related to the Company through common ownership. The Company occupied this
facility upon completion of construction in late November 1998 and the lease
payments commenced in December 1998. The Company also leases 205,000 square
feet in two facilities in Wilmington, Ohio, which houses its distribution and
order fulfillment operations. The Company also operates telemarketing centers
in Dover, Amherst and Keene, New Hampshire, as well as Marlborough,
Massachusetts and Rockville, Maryland. While the Company believes that its
existing distribution facilities in Wilmington, Ohio will be sufficient to
support the Company's anticipated needs through the next twelve months, it is
evaluating additional and/or alternative facilities for distribution to support
future growth.
ITEM 3. Legal Proceedings
The Company currently is not a party to any material legal proceedings,
other than ordinary routine litigation incidental to the business.
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted during the fourth quarter of 2000 to a vote
of security holders.
11
Executive Officers
The executive officers of the Company and their ages as of March 27, 2001
are as follows:
Name Age Position
---- --- --------
Patricia Gallup 47 Chairman of the Board and Chief Executive Officer
David Hall 51 Vice Chairman of the Board
Wayne L. Wilson 52 President and Chief Operating Officer
Robert F. Wilkins 39 Executive Vice President
Mark A. Gavin 39 Senior Vice President of Finance and Chief Financial
Officer
John L. Bomba, Jr. 47 Vice President of Information Services and Chief
Information Officer
Bradley G. Mousseau 49 Vice President of Human Resources
Patricia Gallup is a co-founder of the Company and has served as Chairman of
the Board and Chief Executive Officer of the Company since January 1998. From
September 1995 to January 1998, Ms. Gallup served as the Chairman of the Board,
President and Chief Executive Officer of the Company. From September 1994 to
September 1995, she served as Chairman of the Board and Chief Executive Officer
of the Company. From August 1990 to September 1994, Ms. Gallup served as the
Company's President and Chief Executive Officer.
David Hall is a co-founder of the Company and has served as Vice Chairman of
the Board since November 1997. From June 1997 to November 1997, Mr. Hall served
as the Vice Chairman of the Board, Executive Vice President and Treasurer of
the Company. From February 1995 to June 1997, Mr. Hall served as the Company's
Vice Chairman of the Board and Executive Vice President. From March 1991 to
February 1995, he served as the Executive Vice President of the Company.
Wayne L. Wilson has served as President and Chief Operating Officer of the
Company since January 1998 and Chief Financial Officer from January 1998 to
March 1998. From January 1996 to January 1998, Mr. Wilson served as Senior Vice
President, Chief Operating Officer and Chief Financial Officer of the Company.
From August 1995 to January 1996, he served as Senior Vice President of Finance
and Chief Financial Officer of the Company. Prior to joining the Company, Mr.
Wilson was a partner in the accounting and consulting firm of Deloitte & Touche
LLP from June 1986 to August 1995.
Robert F. Wilkins has served as Executive Vice President of the Company
since January 2000. Mr. Wilkins served as Senior Vice President of Sales and
Marketing from January 1999 to January 2000 and Senior Vice President of
Merchandising and Product Management of the Company from January 1998 to
January 1999. From December 1995 to January 1998, Mr. Wilkins served as Vice
President of Merchandising and Product Management of the Company. From
September 1994 to December 1995 he was a consultant to the Company and certain
of its affiliates. From February 1990 to September 1994, Mr. Wilkins served as
President of Mac's Place.
Mark A. Gavin has served as Senior Vice President of Finance and Chief
Financial Officer since January 2000 and as Vice President of Finance and Chief
Financial Officer of the Company since March 1998. Prior to joining PC
Connection, Mr. Gavin held the position of Executive Vice President and Chief
Operating Officer at CFX Corporation, a bank holding company in Keene, New
Hampshire. Prior to CFX, Mr. Gavin worked as a Manager for Ernst & Young, LLP.
John L. Bomba, Jr. has served as Vice President of Information Services and
Chief Information Officer of the Company since May 1997. From May 1994 to April
1997, Mr. Bomba served as Director of Worldwide Information Systems for Micro
Warehouse, Inc. Prior to May 1994 he served as Director of Professional
Services for Innovative Information Systems, Inc.
Bradley G. Mousseau has served as Vice President of Human Resources since
January 2000. Prior to joining PC Connection, Mr. Mousseau served as Vice
President of Global Workforce Strategies for Systems & Computer Technology
Corporation (SCT) from April 1997 to January 2000. Prior to SCT, Mr. Mousseau
served as Vice President of Human Resources for Gabreili Medical Info Systems.
12
PART II
ITEM 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
Market Information
The Company's Common Stock commenced trading on March 3, 1998 on the Nasdaq
National Market under the symbol "PCCC". As of March 22, 2001, there were
24,418,860 shares outstanding of the Common Stock of the Company held by
approximately 80 stockholders of record.
The following table sets forth for the fiscal periods indicated the range of
high and low bid prices for the Company's Common Stock on the Nasdaq National
Market. These prices reflect the three-for-two stock split distributed on May
23, 2000.
2000 High Low
- ---- ------ ------
Quarter Ended:
December 31..................................................... $56.38 $ 8.63
September 30.................................................... 70.25 42.44
June 30......................................................... 58.50 17.67
March 31........................................................ 23.33 14.17
1999
- ----
Quarter Ended:
December 31..................................................... $23.25 $ 9.11
September 30.................................................... 11.58 8.00
June 30......................................................... 12.67 8.00
March 31........................................................ 18.08 7.42
The Company has never declared or paid cash dividends on its capital stock.
The Company currently anticipates that it will retain all future earnings, if
any, to fund the development and growth of its business and does not anticipate
paying any cash dividends on its Common Stock in the foreseeable future.
ITEM 6. Selected Financial and Operating Data
The following selected financial and operating data should be read in
conjunction with the Company's Consolidated Financial Statements and the Notes
thereto, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere herein. The selected data presented
below under the captions "Statement of Operations Data" and "Balance Sheet
Data" for each of the years in the five-year period ended December 31, 2000 are
derived from the audited financial statements of the Company. The Company's
consolidated financial statements as of December 31, 2000 and 1999 and for each
of the years in the three-year period ended December 31, 2000 and the
independent auditors' report thereon, are included elsewhere herein.
13
Years Ended December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share and selected
operating data)
Statement of Operations
Data:
Net sales(1).......... $1,449,908 $1,080,835 $ 749,905 $ 562,511 $ 340,811
Cost of sales(1)...... 1,273,687 951,489 656,631 486,545 289,606
---------- ---------- ---------- ---------- ----------
Gross profit.......... 176,221 129,346 93,274 75,966 51,205
Selling, general and
administrative
expenses............. 123,972 91,405 68,521 56,596 43,739
Additional
stockholder/officer
compensation(2) ..... -- -- 2,354 12,130 1,259
---------- ---------- ---------- ---------- ----------
Income from
operations........... 52,249 37,941 22,399 7,240 6,207
Interest expense...... (2,086) (1,392) (415) (1,355) (1,269)
Other, net............ 589 116 565 (42) 70
---------- ---------- ---------- ---------- ----------
Income before income
taxes................ 50,752 36,665 22,549 5,843 5,008
Income tax
provision(3)......... (19,289) (13,935) (3,905) (639) (252)
---------- ---------- ---------- ---------- ----------
Net income............ $ 31,463 $ 22,730 $ 18,644 $ 5,204 $ 4,756
========== ========== ========== ========== ==========
Pro Forma Data(4)
----------------------
Basic net income per
share (5).............. $ 1.31 $ .97 $ .61 $ .17
========== ========== ========== ==========
Diluted net income per
share (5).............. $ 1.23 $ .94 $ .59 $ .17
========== ========== ========== ==========
Selected Operating Data:
Active customers(6)... 626,000 732,000 684,000 510,000 424,000
Catalogs distributed.. 45,028,000 47,325,000 42,150,000 33,800,000 18,600,000
Orders entered(7)..... 1,521,000 1,622,000 1,510,000 1,252,000 910,000
Average order
size(7).............. $ 1,115 $ 781 $ 580 $ 524 $ 453
December 31,
----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(dollars in thousands)
Balance Sheet Data:
Working capital....... $ 111,669 $ 72,250 $ 53,768 $ 18,907 $ 14,622
Total assets.......... 250,413 223,537 164,510 105,442 77,358
Short-term debt....... 1,153 1,137 123 29,568 13,057
Long-term debt (less
current maturities):
Capital lease
obligations........ 6,792 6,945 7,081 -- --
Term loan........... -- -- -- 3,250 4,250
Note payable........ 1,000 2,000 -- -- --
Total stockholders'
equity............... 138,687 94,223 69,676 24,120 18,043
- --------
(1) All net sales amounts reflect the reclassification of amounts billed to
customers in sales transactions related to shipping and handling as
revenue, in accordance with the Emerging Issues Task Force (EITF) consensus
on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs."
Previously, the Company recorded such charges as a reduction of cost of
goods sold.
(2) Represents amounts accrued or distributed in excess of aggregate annual
base salaries approved by the Board of Directors prior to the Company's
Initial Public Offering and generally represented Company-related federal
income tax obligations payable by the stockholders.
(3) For all periods prior to March 6, 1998, the Company had been an S
Corporation and, accordingly, had not been subject to federal income taxes.
14
(4) Pro forma adjustments have been made to the historical results of
operations to make the pro forma presentation comparable to what would have
been reported had the Company operated as a C Corporation for 1998 and
1997. The computation of income tax expense was made assuming an effective
tax rate of approximately 39%.
(5) All per share data has been adjusted for a 3-for-2 stock split distributed
on May 23, 2000.
(6) Represents estimates of all customers included in the Company's mailing
list who have made a purchase within the last twelve month period.
(7) Does not reflect cancellations or returns.
15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
consolidated financial statements.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements based on
management's current expectations, estimates and projections about the industry
in which the Company operates, management's beliefs and certain assumptions
made by management. All statements, trends, analyses and other information
contained in this report relative to trends in net sales, gross margin and
anticipated expense levels, as well as other statements, including words such
as "anticipate", "believe", "plan", "estimate" and "intend" and other similar
expressions, constitute forward-looking statements. These forward-looking
statements involve risks and uncertainties, and actual results may differ
materially from those anticipated or expressed in such statements. Potential
risks and uncertainties include, among others, those set forth under the
caption "Factors That May Affect Future Results and Financial Condition"
included within this section. Particular attention should be paid to the
cautionary statements involving the industry's rapid technological change and
exposure to inventory obsolescence, availability and allocations of goods,
reliance on vendor support and relationships, competitive risks, pricing risks,
and economic risks. Except as required by law, the Company undertakes no
obligation to update any forward-looking statement, whether as a result of new
information, future events or otherwise. Readers, however, should carefully
review the factors set forth in other reports or documents that the Company
files from time to time with the Securities and Exchange Commission.
General
The Company was founded in 1982 as a mail-order business offering a broad
range of software and accessories for IBM and IBM-compatible personal
computers. The founders' goal was to provide consumers with superior service
and high quality branded products at competitive prices. The Company initially
sought customers through advertising in selected computer industry publications
and the use of inbound toll-free telemarketing. Currently, the Company seeks to
generate sales through (i) outbound telemarketing by account managers focused
on the business, education and government markets, (ii) inbound calls from
customers responding to the Company's catalogs and other advertising and (iii)
the Company's Internet Web site.
The Company offers both PC compatible products and Mac compatible products.
Reliance on Mac product sales has decreased over the last four years, from
23.0% of net sales in 1996 to 10.3% of net sales for the year ended December
31, 2000. The Company believes that sales attributable to Mac products will
continue to decrease as a percentage of net sales and may also decline in
absolute dollar volume in 2001 and future years.
All of the Company's product categories experienced strong growth for the
year ended December 31, 2000, with sales of networking communications
representing the fastest growing category. Sales of networking communications,
which generally yield a high gross profit margin percentage, relative to other
products, grew by more than 63% in 2000 when compared to 1999. Partially as a
result of the higher networking communication sales, the Company's gross margin
percentage improved for the year ended December 31, 2000. Sales of computer
systems result in a relatively high dollar sales order, as reflected in the
increase in the Company's average order size from $580 in the year ended
December 31, 1998 to $1,115 in the year ended December 31, 2000. Computer
systems generally provide the largest gross profit dollar contribution per
order of all the Company's products, although they usually yield the lowest
gross margin percentage.
The Company's profit margins are also influenced by, among other things,
industry pricing and the relative mix of inbound versus outbound sales.
Generally, pricing in the computer and related products market is very
aggressive, and the Company intends to maintain prices at competitive levels.
Since outbound sales are typically to corporate accounts that purchase at
volume discounts, the gross margin on such sales is generally lower than
inbound sales. However, the gross profit dollar contribution per order is
generally higher as average order sizes of orders to corporate accounts are
usually larger. The Company believes that outbound sales will continue to
represent a larger portion of its business mix in future periods.
16
The direct marketing of personal computers and related products is highly
competitive. In addition to other direct marketers and manufacturers who sell
direct, such as Dell and Gateway, manufacturers of PCs sold by the Company,
such as Apple, Compaq and IBM, have also announced or implemented varying plans
to sell PCs directly to end users. The Company currently believes that direct
sales by Compaq and IBM will not have a significant adverse effect upon the
Company's net sales.
Most product manufacturers provide the Company with co-op advertising
support in exchange for product coverage in the Company's catalogs. Although
the level of co-op advertising support available to the Company from certain
manufacturers has declined, and may decline further in the future, the overall
level of co-op advertising revenues has continued to increase consistent with
the Company's increased levels of spending for catalog and other advertising
programs. The Company believes that the overall levels of co-op advertising
revenues available over the next twelve months will be consistent with the
Company's planned advertising programs.
Results of Operations
The following table sets forth for the periods indicated information derived
from the Company's statements of income expressed as a percentage of net sales.
Years Ended December 31,
--------------------------
2000 1999 1998
-------- -------- ------
Net sales (in millions) $1,449.9 $1,080.8 $749.9
======== ======== ======
Net sales........................................... 100.0% 100.0% 100.0%
Gross profit........................................ 12.2 12.0 12.4
Selling, general and administrative expenses........ 8.6 8.5 9.1
Additional stockholder/officer compensation......... 0.0 0.0 0.3
Income from operations.............................. 3.6 3.5 3.0
Interest expense.................................... (0.1) (0.1) (0.0)
Income before income taxes.......................... 3.5 3.4 3.0
Income taxes........................................ (1.3) (1.3) (0.5)
Net income.......................................... 2.2 2.1 2.5
Pro forma net income................................ 1.8
The following table sets forth the Company's percentage of net sales by
platform, sales channel, and product mix:
Years Ended December 31,
--------------------------
2000 1999 1998
-------- -------- ------
Platform
PC and Multi Platform............................. 90% 85% 81%
Mac............................................... 10 15 19
-------- -------- ------
Total........................................... 100% 100% 100%
======== ======== ======
Sales Channel
Corporate Outbound................................ 76% 65% 53%
Inbound Telesales................................. 16 29 43
On-Line Internet.................................. 8 6 4
-------- -------- ------
Total........................................... 100% 100% 100%
======== ======== ======
Product Mix
Notebooks......................................... 25% 23% 20%
Desktop/Servers................................... 15 15 15
Storage Devices................................... 10 10 11
Software.......................................... 10 12 14
Networking Communications......................... 8 6 6
Printers.......................................... 7 9 8
Video & Monitors.................................. 8 8 8
Memory............................................ 4 4 4
Accessories/Other................................. 13 13 14
-------- -------- ------
Total........................................... 100% 100% 100%
======== ======== ======
17
Sales of enterprise server and networking products (included in the above
product mix) were 17.4%, 11.6% and 7.3% of net sales for the years ended
December 2000, 1999 and 1998, respectively.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Net sales increased $369.1 million, or 34.2%, to $1,449.9 million in 2000
from $1,080.8 million in 1999. The growth in net sales was attributable to (i)
a continued expansion and increased productivity of our outbound telemarketing
group, and (ii) an increased focus on enterprise server and networking product
categories.
As of December 31, 2000, the number of account managers totaled 575, a 67%
increase, compared to 345 account managers at the end of 1999. As a result,
outbound sales increased $394.3 million, or 55.9%, to $1,099.9 million in 2000
from $705.6 million in 1999. Enterprise networking product sales increased
$128.0 million, or 102.4%, to $253.0 million for the year ended December 31,
2000 from $125.0 million in 1999.
Gross profit increased $46.9 million, or 36.3%, to $176.2 million in 2000
from $129.3 million in 1999. The increase in gross profit dollars was
attributable to the increase in net sales described above. Gross profit margin
increased from 12.0% in 1999 to 12.2% in 2000 due to a continuing focus on
solution sales to business, government and educational customers and an
increased focus on higher margin enterprise networking products cited above.
The Company's gross margin may vary based upon vendor support programs, product
mix, pricing strategies, market conditions and other factors.
Selling, general and administrative expenses increased $32.6 million, or
35.7%, to $124.0 million in 2000 from $91.4 million in 1999 and increased as a
percentage of sales to 8.6% in 2000 from 8.5% in 1999. This increase was
attributable to increases in sales personnel, bad debt, and facility costs, and
offset by a decrease in net advertising expense.
Income from operations increased by $14.3 million, or 37.7%, to $52.2
million for the year ended December 31, 2000 from $37.9 million for the
comparable period in 1999. Income from operations as a percentage of net sales
increased from 3.5% in 1999 to 3.6% in 2000 for the reasons discussed above.
Interest expense increased by $.7 million, or 50.0%, to $2.1 million in 2000
from $1.4 million in 1999 due to increased borrowings under the Company's line
of credit necessitated by the Company's growth. Interest expense is offset by
interest income from short-term investments.
The Company's effective tax rate was 38% for both 2000 and 1999.
Net income increased by $8.8 million, or 38.8%, to $31.5 million in 2000
from $22.7 million in 1999, principally as a result of the increase in income
from operations.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Net sales increased $330.9 million, or 44.1%, to $1,080.8 million in 1999
from $749.9 million in 1998. The growth in net sales, which included a 34.6%
increase in average order size, was attributable to (i) continued improvements
in merchandising and product mix, including the stocking and sale of computer
systems; (ii) continued expansion and increased productivity of the Company's
outbound telemarketing group; (iii) an increase in the number of catalog
mailings; and (iv) sales attributed to the acquisition of ComTeq in June 1999.
Notebook computer systems increased to 23.2% of net sales in 1999 from 20.0%
in 1998. Outbound sales increased $306.7 million, or 76.9%, to $705.6 million
in 1999 from $398.9 million in 1998. The number of catalogs mailed increased by
12.1%, from 42.2 million catalogs in 1998 to 47.3 million catalogs in 1999.
Gross profit increased $36.0 million, or 38.6%, to $129.3 million in 1999
from $93.3 million in 1998. The increase in gross profit dollars was
attributable to the increase in net sales described above. Gross profit margin
18
decreased from 12.4% in 1998 to 12.0% in 1999 due to a higher rate of growth in
sales of lower margin computer systems, increased price competition, decreases
in average unit selling prices and an increase in the rate of outbound sales
which generally carry a lower gross margin percentage. However, the Company
continued to generate higher gross profit dollars per order, enabling it to
leverage its operating expenses, as described below. The Company's gross profit
margin may vary based upon vendor support programs, product mix, pricing
strategies, market conditions and other factors.
Selling, general and administrative expenses increased $22.9 million, or
33.4%, to $91.4 million in 1999 from $68.5 million in 1998, but decreased as a
percentage of sales to 8.5% in 1999 from 9.1% in 1998. The increase in expense
was attributable to increases in volume-sensitive costs such as sales personnel
and credit card fees. The decrease as a percentage of net sales was
attributable to the continued leveraging of selling, general and administrative
expenses over a larger sales base.
Additional stockholder/officer compensation paid to the Company's two
principal stockholders in 1998, who also serve as officers and directors,
represented amounts accrued or distributed in excess of aggregate annual base
salaries ($600,000 aggregate base salaries for 1998) approved by the Board of
Directors of the Company and generally represent Company-related federal income
tax obligations payable by the stockholders. There were no such charges in 1999
as the Company was a C Corporation for the entire year.
Income from operations increased by $15.5 million, or 69.2%, to $37.9
million for the year ended December 31, 1999 from $22.4 million for the
comparable period in 1998. Income from operations as a percentage of net sales
increased from 3.0% in 1998 to 3.5% in 1999 for the reasons discussed above.
Interest expense increased by $1.0 million, or 250%, to $1.4 million in 1999
from $.4 million in 1998 due to the capital lease obligation for the Merrimack
facility which began in December 1998 and increased borrowings under the
Company's line of credit.
The tax provision for 1999 reflects a full year of the Company being taxed
as a C Corporation. In 1998, the Company's effective tax rate was 17.3% as a
result of both its taxation as an S Corporation for a part of the year as well
as the recognition of certain deferred tax assets upon conversion to a C
Corporation.
Net income increased by $4.1 million, or 22%, to $22.7 million in 1999 from
$18.6 million in 1998 due to the result of the increase in income from
operations. As described above, 1998 net income was also favorably impacted by
the Company's previous S Corporation status and its conversion to a C
Corporation.
Liquidity and Capital Resources
The Company has historically financed its operations and capital
expenditures through cash flow from operations and bank borrowings. The Company
believes that funds generated from operations, together with available credit
under its bank line of credit, will be sufficient to finance its working
capital and capital expenditure requirements at least for the next twelve
calendar months. The Company's ability to continue funding its planned growth,
both internally and externally, is dependent upon its ability to generate
sufficient cash flow from operations or to obtain additional funds through
equity or debt financing, or from other sources of financing, as may be
required.
At December 31, 2000, the Company had cash and cash equivalents of $7.4
million and working capital of $111.7 million.
Net cash used by operating activities was $4.0 million in the year ended
December 2000, compared to $16.0 million and $29.4 million provided in the
years ended December 31, 1999, and 1998, respectively. The primary factors
historically affecting cash flows from operations are the Company's net income
and changes in the levels of accounts receivable, inventories and accounts
payable. Historically, inventories and accounts payable have increased as a
result of the sales growth of the Company. Accounts payable decreased in 2000
19
due to increased utilization of vendor discounts. Accounts receivable have
increased primarily due to an increase in open account sales to commercial
customers resulting from the Company's continued efforts to increase its sales
to such customers offset in part by a higher rate of increase in accounts
receivable allowances for sales returns and doubtful accounts related to the
growth in sales.
At December 31, 2000, the Company had $86.2 million in outstanding accounts
payable. Such accounts are generally paid within 30 days of incurrence and will
be financed by cash flows from operations or short-term borrowings under the
line of credit. This amount includes $12.1 million payable to two financial
institutions under security agreements to facilitate the purchase of inventory.
Capital expenditures were $12.6 million, $7.7 million and $9.9 million in
the years ended December 31, 2000, 1999 and 1998, respectively. The Company
expects capital expenditures, primarily for the purchase of computer hardware
and software and other fixed assets, to be approximately $8.7 million for the
year ending December 31, 2001.
The Company has an unsecured credit agreement with a bank providing for
short-term borrowings up to $70 million, which bears interest at various rates
ranging from the prime rate (9.50% at December 31, 2000) to prime less 1%,
depending on the ratio of senior debt to EBITDA. The credit agreement includes
various customary financial and operating covenants, including restrictions on
the payment of dividends, none of which the Company believes significantly
restricts its operations. No borrowings were outstanding at December 31, 2000.
In January 2000, the Company used available cash to acquire the Merisel
Americas, Inc. call center in Marlborough, Massachusetts. In 1999, it used
available cash and sellers notes to acquire ComTeq Federal, Inc., a Maryland-
based specialty reseller of computing products to agencies of the federal
government. Management could, in the future, use debt, cash, or stock to effect
additional acquisitions.
Recently Issued Financial Accounting Standards
In June 1998 the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
133") adjusted to be effective for fiscal years beginning after June 15, 2000.
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. Under SFAS 133, certain contracts that
were not formerly considered derivatives may now meet the definition of a
derivative. The Company adopted SFAS 133 effective January 1, 2001. The
adoption of SFAS 133 did not have a significant impact on the financial
position or results of operations of the Company because the Company does not
have significant derivative activity.
In December 1999 the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements." This SAB clarifies certain elements of revenue recognition. Since
December 1999, the SEC has issued several amendments that postponed the
implementation date to the fourth quarter of fiscal 2000. Implementation of the
SAB did not have a material impact on the Company's consolidated financial
statements.
In July 2000 the Emerging Issues Task Force reached a consensus on Issue 00-
10, "Accounting for Shipping and Handling Fees and Costs". The Consensus
specifically stated that all amounts billed to a customer in a sale transaction
related to shipping and handling, if any, represent revenues earned for the
goods provided and should be classified as revenue. It was previously the
Company's policy to record such revenues as a reduction of cost of goods sold.
The Company adopted this Consensus in the fourth quarter of fiscal 2000. All
net sales amounts and gross margin percentages reflect the reclassification of
amounts billed to customers in sales transactions related to shipping and
handling as revenue for all periods presented.
20
Inflation
The Company has historically offset any inflation in operating costs by a
combination of increased productivity and price increases, where appropriate.
The Company does not expect inflation to have a significant impact on its
business in the future.
Factors That May Affect Future Results and Financial Condition
The Company's future results and financial condition are dependent on its
ability to continue to successfully market, sell and distribute computers,
hardware and software. Inherent in this process are a number of factors that
the Company must successfully manage in order to achieve favorable financial
condition and operating results. Potential risks and uncertainties that could
affect the Company's future financial condition and operating results include,
without limitation, the following factors:
The Company has experienced rapid growth in recent years and there is no
assurance that it will be able to manage or sustain such growth.
The Company's net sales have grown from $340.8 million for the year ended
December 31, 1996 to $1.45 billion for the year ended December 31, 2000. This
growth has placed, and any future growth will place, increasing demands on the
Company's administrative, operational, financial and other resources. The
Company's staffing levels and operating expenses have increased and are
expected to increase substantially in the future. The Company also expects that
any future growth will continue to challenge its ability to hire, train,
motivate and manage employees. If the Company's net sales do not increase in
proportion to its operating expenses or if the Company experiences a decrease
in net sales, or its information systems do not expand to meet increasing
demands, or the Company fails to attract, assimilate and retain qualified
personnel or otherwise fails to manage its growth effectively, there would be a
material adverse effect on the Company's results of operations.
The Company may experience quarterly fluctuations and seasonality which could
impact its business.
Several factors have caused the Company's sales and results of operations to
fluctuate, and the Company expects these fluctuations to continue on a
quarterly basis. Causes of these fluctuations include:
. changes in the overall level of economic activity;
. changes in the level of business investment in information technology
products;
. the condition of the personal computer industry in general;
. shifts in demand for hardware and software products;
. industry shipments of new products or upgrades;
. the timing of new merchandise and catalog offerings;
. fluctuations in marketing response rates;
. fluctuations in postage, paper, shipping and printing costs and in
merchandise returns;
. adverse weather conditions that affect response, distribution or
shipping;
. shifts in the timing of holidays; and
. changes in the Company's product offerings.
The Company bases its operating expenditures on sales forecasts. If revenues
do not meet expectations in any given quarter, the Company's operating results
could suffer.
21
In addition, customer response rates to the Company's catalog mailings are
subject to variations. The first and last quarters of the year generally have
higher response rates while the two middle quarters typically have lower
response rates.
The Company is exposed to inventory obsolescence due to the rapid technological
changes occurring in the personal computer industry.
The market for personal computer products is characterized by rapid
technological change and the frequent introduction of new products and product
enhancements. The Company's success depends in large part on its ability to
identify and market products that meet the needs of customers in that
marketplace. In order to satisfy customer demand and to obtain favorable
purchasing discounts, the Company has and may continue to carry increased
inventory levels of certain products. By so doing, it is subject to the
increased risk of inventory obsolescence. Also, in order to implement its
business strategy, the Company intends, among other things, to place larger
than typical inventory stocking orders, and increase participation in first-to-
market purchase opportunities. In the future, the Company may also participate
in end-of-life-cycle purchase opportunities and market products on a private-
label basis, which would increase the risk of inventory obsolescence. In
addition, the Company sometimes acquires special purchase products without
return privileges. There can be no assurance that the Company will be able to
avoid losses related to obsolete inventory. In addition, manufacturers are
limiting return rights and are also taking steps to reduce their inventory
exposure by supporting "build to order" programs authorizing distributors and
resellers to assemble computer hardware under the manufacturers' brands. These
trends reduce the costs to manufacturers and shift the burden of inventory risk
to resellers like the Company which could negatively impact the Company's
financial condition.
The Company acquires products for resale from a limited number of vendors; the
loss of any one of these vendors could have a material adverse effect on its
business.
The Company acquires products for resale both directly from manufacturers
and indirectly through distributors and other sources. The five vendors
supplying the greatest amount of goods to the Company constituted 54.4% and
50.7% of the Company's total product purchases in the years ended December 31,
2000 and 1999, respectively. Among these five vendors, purchases from Ingram
Micro, Inc. represented 25.6% and 21.7% of the Company's total product
purchases in the years ended December 31, 2000 and 1999, respectively.
Purchases from Tech Data Corporation comprised 11.2% and 7.0% of the Company's
total product purchases in the years ended December 31, 2000 and 1999,
respectively. No other vendor supplied more than 10% of the Company's total
product purchases in the year ended December 31, 2000. If the Company were
unable to acquire products from Ingram Micro, Inc., the Company could
experience a short-term disruption in the availability of products and such
disruption could have a material adverse effect on the Company's results of
operations and cash flows.
Substantially all of the Company's contracts and arrangements with its
vendors that supply significant quantities of products are terminable by such
vendors or the Company without notice or upon short notice. Most of the
Company's product vendors provide it with trade credit, of which the net amount
outstanding at December 31, 2000 was $86.2 million. Termination, interruption
or contraction of relationships with the Company's vendors, including a
reduction in the level of trade credit provided to the Company, could have a
material adverse effect on the Company's financial position.
Some product manufacturers either do not permit the Company to sell the full
line of their products or limit the number of product units available to direct
marketers such as the Company. An element of the Company's business strategy is
to increase its participation in first-to-market purchase opportunities. The
availability of certain desired products, especially in the direct marketing
channel, has been constrained in the past. The Company could experience a
material adverse effect to its business if the Company is unable to source
first-to-market purchase or similar opportunities, or if the Company faces the
reemergence of significant availability constraints.
22
The Company may experience a reduction in the incentive programs offered to it
by vendors.
Some product manufacturers and distributors provide the Company with
incentives such as supplier reimbursements, payment discounts, price
protection, rebates and other similar arrangements. The increasingly
competitive computer hardware market has already resulted in the following:
. reduction or elimination of some of these incentive programs,
. more restrictive price protection and other terms; and
. in some cases, reduced advertising allowances and incentives.
Most product manufacturers provide the Company with co-op advertising
support and in exchange the Company covers their products in the Company's
catalogs. This support significantly defrays the Company's catalog production
expense. In the past, the Company has experienced a decrease in the level of
co-op advertising support available to it from certain manufacturers. The level
of co-op advertising support the Company receives from some manufacturers may
further decline in the future. Such a decline could increase the Company's
selling, general and administrative expenses as a percentage of sales and have
a material adverse effect on the Company's cash flows.
The Company faces many competitive risks.
The direct marketing industry and the computer products retail business, in
particular, are highly competitive. The Company competes with consumer
electronics and computer retail stores, including superstores. The Company also
competes with other direct marketers of hardware and software and computer
related products, including an increasing number of Internet retailers, some of
which sell products at or below cost. Certain hardware and software vendors are
selling their products directly through their own catalogs and over the
Internet. The Company competes not only for customers, but also for co-op
advertising support from personal computer product manufacturers. Some of the
Company's competitors have greater financial and marketing resources, larger
catalog circulations and customer bases, and other resources than does the
Company. In addition, many of the Company's competitors offer a wider range of
products and services than it does and may be able to respond more quickly to
new or changing opportunities, technologies and customer requirements. Many
current and potential competitors also have greater name recognition, engage in
more extensive promotional activities and adopt more aggressive pricing
policies than the Company. The Company expects competition to increase as
retailers and direct marketers who have not traditionally sold computers and
related products enter the industry.
The Company cannot assure that it can continue to compete effectively
against its current or future competitors. In addition, price is an important
competitive factor in the personal computer hardware and software market and
the Company cannot assure that the Company will not face increased price
competition. If the Company encounters new competition or fails to compete
effectively against competitors, its business could be adversely affected.
In addition, product resellers and direct marketers are combining operations
or acquiring or merging with other resellers and direct marketers to increase
efficiency. Moreover, current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties to
enhance their products and services. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and acquire significant
market share.
The Company faces and will continue to face significant and intense price
competition.
Generally, pricing is very aggressive in the personal computer industry and
the Company expects pricing pressures to continue. An increase in price
competition could result in a reduction of the Company's profit margins. There
can be no assurance that the Company will be able to offset the effects of
price reductions with an increase in the number of customers, higher sales,
cost reductions or otherwise. Also, the Company's recent
23
increase in sales of personal computer hardware products are generally
producing lower profit margins than those associated with software products.
Such pricing pressures could result in an erosion of the Company's market
share, reduced sales and reduced operating margins, any of which could have a
material adverse effect on the Company's business.
The methods of distributing computers and related products are changing and
such changes may negatively impact the Company and its business.
The manner in which computers and related products are distributed and sold
is changing, and new methods of distribution and sale, such as on-line shopping
services, have emerged. Hardware and software manufacturers have sold, and may
intensify their efforts to sell, their products directly to end-users. From
time to time, certain manufacturers have instituted programs for the direct
sales of large order quantities of hardware and software to certain major
corporate accounts. These types of programs may continue to be developed and
used by various manufacturers. Some of the Company's vendors, including Apple,
Compaq and IBM, currently sell some of their products directly to end-users and
have stated their intentions to increase the level of such direct sales. In
addition, manufacturers may attempt to increase the volume of software products
distributed electronically to end-users. An increase in the volume of products
sold through or used by consumers of any of these competitive programs or
distributed electronically to end-users could have a material adverse effect on
the Company's results of operations.
The Company could experience system failures which would interfere with its
ability to process orders.
The Company depends on the accuracy and proper use of its management
information systems including its telephone system. Many of the Company's key
functions depend on the quality and effective utilization of the information
generated by its management information systems, including:
. the Company's ability to manage inventory and accounts receivable
collection;
. the Company's ability to purchase, sell and ship products efficiently
and on a timely basis; and
. the Company's ability to maintain operations.
Interruptions could result from natural disasters as well as power loss,
telecommunications failure and similar events.
The Company's management information systems require continual upgrades to
most effectively manage its operations and customer database. Although the
Company maintains some redundant systems, with full data backup, a substantial
interruption in management information systems or in telephone communication
systems would substantially hinder its ability to process customer orders and
thus could have a material adverse effect on the Company's business.
The Company may not have sufficient distribution facilities to support future
growth.
The Company's current distribution facilities may be inadequate to support
any significant growth in the future. The Company currently occupies two
buildings aggregating 205,000 square feet in Wilmington, Ohio under leases
which expire in 2002 and 2003. There is no assurance that the Company can renew
these leases on favorable terms or at all. The Company is continually assessing
its needs for additional distribution facilities. There can be no assurance
that suitable commercial facilities will be available, or if available, that
such facilities would be available at commercially reasonable rates.
The Company relies on the continued development of electronic commerce and
Internet infrastructure development.
The Company's level of sales made over the Internet has increased in part
because of the growing use and acceptance of the Internet by end-users. This
growth is a recent development. No one can be certain that
24
acceptance and use of the Internet will continue to develop or that a
sufficiently broad base of consumers will adopt and continue to use the
Internet and other online services as a medium of commerce. Sales of computer
products over the Internet do not currently represent a significant portion of
overall computer product sales. Growth of the Company's Internet sales is
dependent on potential customers using the Internet in addition to traditional
means of commerce to purchase products. The Company cannot accurately predict
the rate at which they will do so.
The Company's success in growing its Internet business will depend in large
part upon the development of an infrastructure for providing Internet access
and services. If the number of Internet users or their use of Internet
resources continues to grow rapidly, such growth may overwhelm the existing
Internet infrastructure. The Company's ability to increase the speed with which
it provides services to customers and to increase the scope of such services
ultimately is limited by and reliant upon the speed and reliability of the
networks operated by third parties. The Company cannot assure that networks and
infrastructure providing sufficient capacity and reliability will continue to
be developed.
The Company depends heavily on third-party shippers to deliver its products to
customers.
The Company ships approximately 62% of its products to customers by Airborne
Freight Corporation D/B/A "Airborne Express", with the remainder being shipped
by United Parcel Service of America, Inc. and other overnight delivery and
surface services. A strike or other interruption in service by these shippers
could adversely affect the Company's ability to market or deliver products to
customers on a timely basis.
The Company may experience potential increases in shipping, paper and postage
costs, which may adversely effect its business if the Company were not able to
pass such increases on to its customers.
Shipping costs are a significant expense in the operation of the Company's
business. Increases in postal or shipping rates and paper costs could
significantly impact the cost of producing and mailing the Company's catalogs
and shipping customer orders. Postage prices and shipping rates increase
periodically and the Company has no control over future increases. The Company
has a long-term contract with Airborne Express whereby it ships products to the
Company's customers. The Company believes that it has negotiated favorable
shipping rates with Airborne. The Company generally invoices customers for
shipping and handling charges. There can be no assurance that the Company will
be able to pass on to its customers the full cost, including any future
increases in the cost, of commercial delivery services such as Airborne
Express.
The Company also incurs substantial paper and postage costs related to its
marketing activities, including producing and mailing its catalogs. Paper
prices historically have been cyclical and the Company has experienced
substantial increases in the past. Significant increases in postal or shipping
rates and paper costs could adversely impact the Company's business, financial
condition and results of operations, particularly if the Company cannot pass on
such increases to its customers or offset such increases by reducing other
costs.
Privacy concerns with respect to list development and maintenance may
materially adversely affect the Company's business.
The Company mails catalogs and sends electronic messages to names in its
proprietary customer database and to potential customers whose names the
Company obtains from rented or exchanged mailing lists. Worldwide public
concern regarding personal privacy has subjected the rental and use of customer
mailing lists and other customer information to increased scrutiny. Any
domestic or foreign legislation enacted limiting or prohibiting these practices
could negatively affect the Company's business.
The Company faces many uncertainties relating to the collection of state sales
or use tax.
The Company presently collects sales tax only on taxable sales of products
to residents of Ohio, Tennessee, Maryland, Massachusetts and Virginia. The
Company began collecting sales tax in Massachusetts in
25
January 2000. Taxable sales to customers located within Ohio, Tennessee,
Maryland, Massachusetts and Virginia were approximately 9% of the Company's net
sales during the year ended December 31, 2000. Various states have sought to
impose on direct marketers the burden of collecting state sales taxes on the
sales of products shipped to their residents. In 1992, the United States
Supreme Court affirmed its position that it is unconstitutional for a state to
impose sales or use tax collection obligations on an out-of-state mail order
company whose only contacts with the state are limited to the distribution of
catalogs and other advertising materials through the mail and the subsequent
delivery of purchased goods by United States mail or by interstate common
carrier. However, legislation that would expand the ability of states to impose
sales tax collection obligations on direct marketers has been introduced in
Congress on many occasions. Due to its presence on various forms of electronic
media and other factors, the Company's contact with many states may exceed the
contact involved in the Supreme Court case. The Company cannot predict the
level of contact that is sufficient to permit a state to impose on us a sales
tax collection obligation. If the Supreme Court changes its position or if
legislation is passed to overturn the Supreme Court's decision, the imposition
of a sales or use tax collection obligation on the Company in states to which
the Company ships products would result in additional administrative expenses
to the Company, could result in price increases to its customers, and could
reduce demand for its product.
The Company is dependent on key personnel.
The Company's future performance will depend to a significant extent upon
the efforts and abilities of its senior executives. The competition for
qualified management personnel in the computer products industry is very
intense, and the loss of service of one or more of these persons could have an
adverse effect on the Company's business. The Company's success and plans for
future growth will also depend on its ability to hire, train and retain skilled
personnel in all areas of its business, including sales account managers and
technical support personnel. There can be no assurance that the Company will be
able to attract, train and retain sufficient qualified personnel to achieve the
Company's business objectives.
The Company is controlled by two principal stockholders.
Patricia Gallup and David Hall, the Company's two principal stockholders,
beneficially own or control, in the aggregate, approximately 71% of the
outstanding shares of the Company's common stock. Because of their beneficial
stock ownership, these stockholders can continue to elect the members of the
Board of Directors and decide all matters requiring stockholder approval at a
meeting or by a written consent in lieu of a meeting. Similarly, such
stockholders can control decisions to adopt, amend or repeal the Company's
charter and bylaws, or take other actions requiring the vote or consent of the
Company's stockholders and prevent a takeover of the Company by one or more
third parties, or sell or otherwise transfer their stock to a third party,
which could deprive the Company's stockholders of a control premium that might
otherwise be realized by them in connection with an acquisition of the Company.
Such control may result in decisions that are not in the best interest of the
Company's public stockholders. In connection with the Company's initial public
offering, the principal stockholders placed all except 60,000 of the shares of
common stock beneficially owned by them into a voting trust, pursuant to which
they are required to agree as to the manner of voting such shares in order for
the shares to be voted. Such provisions could discourage bids for the Company's
common stock at a premium as well as have a negative impact on the market price
of the Company's common stock.
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk
The Company invests cash balances in excess of operating requirements in
short-term securities, generally with maturities of 90 days or less. In
addition, the Company's unsecured credit agreement provides for borrowings
which bear interest at variable rates based on the prime rate. The Company had
no borrowings outstanding pursuant to the credit agreement as of December 31,
2000. The Company believes that the effect, if any, of reasonably possible
near-term changes in interest rates on the Company's financial position,
results of operations and cash flows should not be material.
26
The Company's credit agreement exposes earnings to changes in short-term
interest rates since interest rates on the underlying obligations are variable.
The fair value of the Company's credit agreement is not significantly affected
by changes in market interest rates, as the change in fair value of the
Company's long-term debt resulting from a hypothetical 10% increase or decrease
in interest rates is not material.
ITEM 8. Consolidated Financial Statements and Supplementary Data
The information required by this Item is included in this Report beginning
at page F-1.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information included under the captions "Information Concerning
Directors, Nominees and Executive Officers" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive Proxy Statement for
its 2001 Annual Meeting of Stockholders to be held on May 24, 2001 (the "Proxy
Statement") is incorporated herein by reference. The Company anticipates filing
the Proxy Statement within 120 days after December 31, 2000. With the exception
of the foregoing information and other information specifically incorporated by
reference into this Form 10-K, the Proxy Statement is not being filed as a part
hereof.
ITEM 11. Executive Compensation
The information under the caption "Executive Compensation" in the Proxy
Statement is incorporated herein by reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The information under the heading "Security Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement is incorporated herein by
reference.
ITEM 13. Certain Relationships and Related Transactions
The information under the heading "Certain Transactions and Relationships"
in the Proxy Statement is incorporated herein by reference.
27
PART IV
ITEM 14. Exhibits, Consolidated Financial Statements, Schedule, and Reports on
Form 8-K
(a) List of Documents Filed as Part of This Report:
(1) Consolidated Financial Statements
The consolidated financial statements listed below are included in
this document.
Consolidated Financial Statements Page References
--------------------------------- ---------------
Report of Management.................................... F-2
Independent Auditors' Report............................ F-3
Consolidated Balance Sheets............................. F-4
Consolidated Statements of Income....................... F-5
Consolidated Statement of Changes in Stockholders'
Equity................................................. F-6
Consolidated Statements of Cash Flows................... F-7
Notes to Consolidated Financial Statements.............. F-8
(2) Consolidated Financial Statement Schedule:
The following Consolidated Financial Statement Schedule of the
Company as set forth below is filed with this report:
Schedule Page Reference
-------- --------------
Schedule II--Valuation and Qualifying Accounts............ S-1
(3) Supplementary Data
Not applicable.
(b) Reports on Form 8-K
Not applicable.
(c) Exhibits
The exhibits listed below are filed herewith or are incorporated herein
by reference to other filings.
28
EXHIBIT INDEX
Exhibits Page Reference
-------- --------------
*3.2 Amended and Restated Certificate of Incorporation of Registrant.
*3.4 Bylaws of Registrant.
*4.1 Form of specimen certificate for shares of Common Stock, $0.01 par
value per share, of the Registrant.
*9.1 Form of 1998 PC Connection Voting Trust Agreement among the
Registrant, Patricia Gallup individually and as a trustee, and David
Hall individually and as trustee.
*10.1 1993 Incentive and Non-Statutory Stock Option Plan, as amended.
*10.2 1997 Stock Incentive Plan.
*10.3 Lease between the Registrant and Miller-Valentine Partners, dated
September 24, 1990, as amended, for property located at 2870 Old
State Route 73, Wilmington, Ohio.
*10.4 Lease between the Registrant and Gallup & Hall partnership, dated May
1, 1997, for property located at 442 Marlboro Street, Keene, New
Hampshire.
*10.5 Lease between the Registrant and Gallup & Hall partnership, dated
June 1, 1987, as amended, for property located in Marlow, New
Hampshire.
*10.6 Lease between the Registrant and Gallup & Hall partnership, dated
July 22, 1998, for property located at 450 Marlboro Street, Keene,
New Hampshire.
*10.7 Lease between the Registrant and Dataproducts Corporation, dated June
22, 1993, as amended, for property located at 528 Route 13 South,
Milford, New Hampshire.
*10.8 Amended and Restated Lease between the Registrant and G&H Post, LLC,
dated December 29, 1997 for property located at Route 101A,
Merrimack, New Hampshire.
*10.9 Employment Agreement between the Registrant and Wayne L. Wilson,
dated August 16, 1995.
*10.10 Employment Agreement between the Registrant and Robert F. Wilkins,
dated December 23, 1995.
*10.11 Letter Agreement between the Registrant and Airborne Freight
Corporation D/B/A "Airborne Express," dated April 30, 1990, as
amended.
*10.12 Agreement between the Registrant and Ingram Micro, Inc., dated
October 30, 1997, as amended.
*10.13 Employment Agreement, dated as of January 1, 1998, between the
Registrant and Patricia Gallup.
*10.14 Form of Registration Rights Agreement among the Registrant, Patricia
Gallup, David Hall and the 1998 PC Connection Voting Trust.
**10.15 Amendment No. 1 to Amended and Restated Lease between the Registrant
and G&H Post, LLC, dated December 29, 1998 for property located at
Route 101A, Merrimack, New Hampshire.
**10.16 Employment Agreement between the Registrant and John L. Bomba, dated
March 28, 1997.
**10.17 Employment Agreement between the Registrant and Mark A. Gavin, dated
February 5, 1998.
***10.18 Agreement for Wholesale Financing, dated as of March 25, 1998,
between the Registrant and Deutsche Financial Services Corporation.
***10.19 Amendment to Agreement for Wholesale Financing, dated as of March 25,
1998, between the Registrant and Deutsche Financial Services
Corporation.
***10.20 Amendment to Agreement for Wholesale Financing, dated as of November
5, 1999, between the Registrant and Deutsche Financial Services
Corporation.
29
Exhibits Page Reference
-------- --------------
***10.21 Amendment to Agreement for Wholesale Financing, dated as of February
25, 2000 between the Registrant and Deutsche Financial Services
Corporation.
***10.22 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc. in connection with the Amendment to Agreement for
Wholesale Financing, dated as of February 25, 2000, between the
Registrant and Deutsche Financial Services Corporation.
***10.23 Agreement for Inventory Financing, dated as of August 17, 1999,
between the Registrant and IBM Credit Corporation.
***10.24 Amendment to Agreement for Inventory Financing, dated as of February
25, 2000, between the Registrant and IBM Credit Corporation.
***10.25 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc., PC Connection Sales of Massachusetts, Inc.,
Merrimack Services Corp. and ComTeq Federal, Inc., in connection
with the Amendment to Agreement for Inventory Financing, dated as of
February 25, 2000, between the Registrant and IBM Credit
Corporation.
***10.26 Agreement for Wholesale Financing, dated as of October 12, 1993,
between ComTeq Federal, Inc. and IBM Credit Corporation.
***10.27 Amendment to Agreement for Wholesale Financing, dated as of December
23, 1999, between ComTeq Federal, Inc. and IBM Credit Corporation.
***10.28 Amendment to Addendum to Agreement for Wholesale Financing, dated as
of December 23, 1999, between ComTeq Federal, Inc. and IBM Credit
Corporation.
***10.29 Amendment to Agreement for Wholesale Financing, dated as of February
25, 2000, between ComTeq Federal, Inc. and IBM Credit Corporation.
***10.30 Guaranty, dated as of February 25, 2000, entered into by the
Registrant, PC Connection, Inc., PC Connection Sales of
Massachusetts, Inc. and Merrimack Services Corp., in connection with
the Amendment to Agreement for Wholesale Financing, dated as of
February 25, 2000, between ComTeq Federal, Inc. and IBM Credit
Corporation.
***10.31 Agreement for Wholesale Financing, dated as of February 25, 2000,
between ComTeq Federal, Inc. and Deutsche Financial Services
Corporation.
***10.32 Guaranty, dated as of February 25, 2000, entered into by PC
Connection, Inc. in connection with the Agreement for Wholesale
Financing, dated as of February 25, 2000, between ComTeq Federal,
Inc. and Deutsche Financial Services Corporation.
***10.33 Assignment of Lease Agreements, dated as of December 13, 1999,
between Micro Warehouse, Inc. (assignor) and the Registrant
(assignee).
***10.34 Amended and Restated Credit Agreement, dated February 25, 2000,
between PC Connection, Inc., the Lenders Party hereto and Citizens
Bank of Massachusetts.
10.35 Amendment, dated January 1, 1999, to the Lease Agreement between the
Registrant and Gallup & Hall Partnership, dated June 1, 1987, as
amended for property located in Marlow, New Hampshire.
****10.36 Lease between Merrimack Services Corporation and White Knight Realty
Trust, dated October 19, 2000 for property located at 7 Route 101A,
Amherst, New Hampshire.
10.37 Amendment to Employment Agreement between the Registrant and Robert
Wilkins dated December 23, 1995.
10.38 Lease between Merrimack Services Corporation and Schleicher &
Schuell, Inc., dated November 16, 2000 for property located at 10
Optical Avenue, Keene, New Hampshire.
10.39 Lease between PC Connection Sales and Dover Mills L.P., dated May 1,
2000 for property located at 100 Main Street, Dover, New Hampshire.
10.40 Lease between Comteq Federal, Inc. and Rockville Office/Industrial
Associates dated December 14, 1993 for property located at 7503
Standish Place, Rockville, Maryland.
30
Exhibits Page Reference
-------- --------------
10.41 Amendment, dated November 1, 1996 to the Lease Agreement between
ComTeq Federal, Inc. and Rockville Office/Industrial Associates for
property located in Rockville, Maryland.
10.42 Amendment, dated March 31, 1998 to the Lease Agreement between ComTeq
Federal, Inc. and Rockville Office/Industrial Associates, dated
November 1, 1996, as amended for property located in Rockville,
Maryland.
10.43 Amendment, dated August 31, 2000 to the Lease Agreement between
ComTeq Federal, Inc. and Rockville Industrial Associates, dated March
31, 1998, as amended for property located in Rockville, Maryland.
10.44 Amendment dated June 26, 2000 to the Lease Agreement between
Merrimack Services Corporation and EWE Warehouse Investments V, LTD.,
dated July 31, 1998 for property located at 2840 Old State Route 73,
Wilmington, Ohio.
10.45 Lease between PC Connection, Inc. and The Hillsborough Group, dated
January 5, 2000 for property located at 706 Route 101A, Merrimack,
New Hampshire.
21.1 Subsidiaries of Registrant.
23.1 Consent of Deloitte & Touche LLP.
- --------
* Incorporated by reference from the exhibits filed with the Company's
registration statement (333-41171) on Form S-1 filed under the Securities
Act of 1933.
** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K, File Number 0-23827, filed on March 31, 1999.
*** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K/A Amendment No. 1, File Number 0-23827, filed on April
4, 2000.
**** Incorporated by reference from exhibits filed with the Company's quarterly
report on Form 10-Q, File Number 0-23827, filed on November 14, 2000.
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
PC Connection, Inc.
By: /s/ Patricia Gallup
Date: March 30, 2001 ----------------------------------
Patricia Gallup,
Chairman and CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Patricia Gallup CEO and Director March 30, 2001
_______________________________ (Principal Executive Officer)
Patricia Gallup
/s/ Wayne L. Wilson President and COO March 30, 2001
_______________________________ (Principal Operating Officer)
Wayne L. Wilson
/s/ Peter J. Baxter Director March 30, 2001
_______________________________
Peter J. Baxter
/s/ David Beffa-Negrini Director March 30, 2001
_______________________________
David Beffa-Negrini
/s/ Mark A. Gavin Chief Financial Officer March 30, 2001
_______________________________ (Principal Financial and Accounting
Mark A. Gavin Officer)
/s/ David Hall Vice Chairman and Director March 30, 2001
_______________________________
David Hall
/s/ Martin C. Murrer Director March 30, 2001
_______________________________
Martin C. Murrer
32
PC CONNECTION, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Management..................................................... F-2
Independent Auditors' Report............................................. F-3
Consolidated Balance Sheets as of December 31, 2000 and 1999............. F-4
Consolidated Statements of Income for the years ended December 31, 2000,
1999, and 1998.......................................................... F-5
Consolidated Statement of Changes in Stockholders' Equity for the years
ended December 31, 2000, 1999, and 1998................................. F-6
Consolidated Statements of Cash Flows for the years ended December 31,
2000, 1999, and 1998.................................................... F-7
Notes to Consolidated Financial Statements............................... F-8
F-1
REPORT OF MANAGEMENT
Responsibility for the integrity and objectivity of the financial
information presented in this Annual Report on Form 10-K rests with PC
Connection, Inc. and subsidiaries ("the Company") management. The accompanying
consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America,
applying certain estimates and judgments as required.
The Company maintains an effective internal control structure. It consists,
in part, of an organization with clearly defined lines of responsibility and
delegation of authority, comprehensive systems and control procedures. We
believe this structure provides reasonable assurance that transactions are
executed in accordance with management authorization and accounting principles
generally accepted in the United States of America.
To assure the effective administration of internal control, we carefully
select and train our employees, develop and disseminate written policies and
procedures, provide appropriate communication channels and foster an
environment conducive to the effective functioning of controls. We believe that
it is essential for the Company to conduct its business affairs in accordance
with the highest ethical standards.
Deloitte & Touche LLP, independent auditors, is retained to audit the
Company's consolidated financial statements. Its accompanying report is based
on an audit conducted in accordance with auditing standards generally accepted
in the United States of America.
The Audit Committee of the Board of Directors is composed solely of outside
directors and is responsible for recommending to the Board of Directors the
independent accounting firm to be retained for the coming year. The Audit
Committee meets periodically and privately with the independent auditors, as
well as with Company management, to review accounting, auditing, internal
control structure and financial reporting matters.
Patricia Gallup Wayne L. Wilson Mark A. Gavin
Chairman and Chief Executive President and Chief Operating Chief Financial
Officer Officer Officer
F- 2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
PC Connection, Inc. and Subsidiaries
Merrimack, New Hampshire
We have audited the accompanying consolidated balance sheets of PC
Connection, Inc. and subsidiaries as of December 31, 2000 and 1999, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2000.
Our audits also included the financial statement schedule listed in Item
14(a)(2). These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of PC Connection, Inc. and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As discussed in Note 1 to the financial statements, in accordance with
Emerging Issues Task Force consensus on Issue 00-10, "Accounting for Shipping
and Handling Fees and Costs", the Company has recorded certain
reclassifications of amounts billed to customers for shipping and handling
fees.
Deloitte & Touche LLP
Boston, Massachusetts
January 25, 2001
F-3
PC CONNECTION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)
December 31,
-----------------
2000 1999
-------- --------
ASSETS
Current Assets:
Cash and cash equivalents.................................. $ 7,363 $ 20,416
Accounts receivable, net................................... 139,644 99,405
Inventories--merchandise................................... 54,679 64,348
Deferred income taxes...................................... 2,175 1,991
Income taxes receivable.................................... 4,882 1,403
Prepaid expenses and other current assets.................. 3,064 3,248
-------- --------
Total current assets..................................... 211,807 190,811
Property and equipment, net.................................. 28,665 23,126
Other assets................................................. 432 169
Goodwill..................................................... 9,509 9,431
-------- --------
Total Assets............................................. $250,413 $223,537
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease obligation to
affiliate................................................. $ 153 $ 137
Current maturities of long-term debt....................... 1,000 1,000
Accounts payable........................................... 86,216 105,547
Accrued expenses and other liabilities..................... 12,769 11,877
-------- --------
Total current liabilities................................ 100,138 118,561
Long-term debt, less current maturities...................... 1,000 2,000
Capital lease obligation to affiliate, less current
maturities.................................................. 6,792 6,945
Deferred taxes............................................... 3,555 1,579
Other liabilities............................................ 241 229
-------- --------
Total Liabilities........................................ 111,726 129,314
-------- --------
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Preferred Stock, $.01 par value, 7,500 shares authorized, 0
outstanding at December 31, 2000 and December 31, 1999.... -- --
Common Stock, $.01 par value, 30,000 shares authorized,
24,416 and 23,653 issued and outstanding at December 31,
2000 and December 31, 1999, respectively.................. 244 237
Additional paid-in capital................................... 71,542 58,548
Retained earnings............................................ 66,901 35,438
-------- --------
Total Stockholders' Equity............................... 138,687 94,223
-------- --------
Total Liabilities and Stockholders' Equity............... $250,413 $223,537
======== ========
See notes to consolidated financial statements.
F-4
PC CONNECTION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share data)
Years Ended December 31,
--------------------------------
2000 1999 1998
---------- ---------- --------
Net sales................................... $1,449,908 $1,080,835 $749,905
Cost of sales............................... 1,273,687 951,489 656,631
---------- ---------- --------
Gross Profit.............................. 176,221 129,346 93,274
Selling, general and administrative
expenses................................... 123,972 91,405 68,521
Additional stockholder/officer
compensation............................... -- -- 2,354
---------- ---------- --------
Income from operations.................... 52,249 37,941 22,399
Interest expense............................ (2,086) (1,392) (415)
Other, net.................................. 589 116 565
---------- ---------- --------
Income before taxes......................... 50,752 36,665 22,549
Income taxes................................ (19,289) (13,935) (3,905)
---------- ---------- --------
Net income................................ $ 31,463 $ 22,730 $ 18,644
========== ========== ========
Earnings per common share:
Basic..................................... $ 1.31 $ .97
========== ==========
Diluted................................... $ 1.23 $ .94
========== ==========
Pro forma data:
Historical income before income taxes..... $ 22,549
Pro forma income taxes.................... (8,721)
--------
Pro forma net income...................... $ 13,828
========
Pro forma basic net income per share...... $ .61
========
Pro forma diluted net income per share.... $ .59
========
See notes to consolidated financial statements.
F-5
PC CONNECTION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(amounts in thousands)
Common Stock Additional
------------- Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ---------- -------- --------
Balance, December 31, 1997....... 17,699 $177 $ 4,038 $ 19,905 $ 24,120
Net proceeds from initial public
offering........................ 5,391 54 57,199 -- 57,253
Dividend......................... -- -- (7,196) (25,841) (33,037)
Exercise of stock options,
including income tax benefits... 318 3 1,396 -- 1,399
Compensation under nonstatutory
stock option agreements......... -- -- 1,297 -- 1,297
Net income....................... -- -- -- 18,644 18,644
------ ---- ------- -------- --------
Balance, December 31, 1998....... 23,408 234 56,734 12,708 69,676
------ ---- ------- -------- --------
Exercise of stock options,
including income tax benefits... 176 2 1,182 -- 1,184
Issuance of stock under employee
stock purchase plan............. 69 1 470 -- 471
Compensation under nonstatutory
stock option agreements......... -- -- 162 -- 162
Net income....................... -- -- -- 22,730 22,730
------ ---- ------- -------- --------
Balance, December 31, 1999....... 23,653 237 58,548 35,438 94,223
------ ---- ------- -------- --------
Exercise of stock options,
including income tax benefits... 687 6 12,012 -- 12,018
Issuance of stock under employee
stock purchase plan............. 76 1 931 -- 932
Compensation under nonstatutory
stock option agreements......... -- -- 51 -- 51
Net income....................... -- -- -- 31,463 31,463
------ ---- ------- -------- --------
Balance, December 31, 2000....... 24,416 $244 $71,542 $ 66,901 $138,687
====== ==== ======= ======== ========
See notes to consolidated financial statements.
F-6
PC CONNECTION, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
Years Ended December 31,
-------------------------------
2000 1999 1998
--------- --------- ---------
Cash Flows from Operating Activities:
Net income.................................. $ 31,463 $ 22,730 $ 18,644
Adjustments to reconcile net income to net
cash provided by (used for) operating
activities:
Depreciation and amortization............. 6,566 5,334 2,866
Deferred income taxes..................... 1,540 2,153 (3,121)
Compensation under nonstatutory stock
option agreements........................ 51 162 1,297
Provision for doubtful accounts........... 9,868 6,821 6,296
(Gain)/loss on disposal of fixed assets... (13) 159 --
Changes in assets and liabilities:
Accounts receivable....................... (49,607) (42,795) (35,265)
Inventories............................... 9,669 (305) 295
Prepaid expenses and other current
assets................................... (3,295) (504) (1,910)
Other non-current assets.................. (263) -- --
Accounts payable.......................... (19,077) 19,945 39,387
Amounts payable to stockholders........... -- -- (1,185)
Income tax benefits from exercise of stock
options.................................. 8,193 370 1,176
Accrued expenses and other liabilities.... 897 1,969 926
--------- --------- ---------
Net cash provided by (used for) operating
activities................................. (4,008) 16,039 29,406
--------- --------- ---------
Cash Flows from Investing Activities:
Purchases of property and equipment......... (12,581) (7,653) (9,922)
Proceeds from sale of property and
equipment.................................. 2,074 2,155 58
Payment for acquistions, net of cash
acquired................................... (2,158) (3,198) --
--------- --------- ---------
Net cash used for investing activities...... (12,665) (8,696) (9,864)
--------- --------- ---------
Cash Flows from Financing Activities:
Proceeds from short-term borrowings......... 583,042 442,731 160,098
Repayment of short-term borrowings.......... (583,042) (442,731) (188,416)
Repayment of notes payable.................. (1,000) -- (4,500)
Repayment of capital lease obligation to
affiliate.................................. (137) (122) (11)
Issuance of stock upon exercise of
nonstatutory stock options................. 3,825 814 223
Issuance of stock under employee stock
purchase plan.............................. 932 471 --
Net proceeds from initial public offering... -- -- 57,253
Payment of dividend......................... -- -- (33,037)
--------- --------- ---------
Net cash provided by (used for) financing
activities................................. 3,620 1,163 (8,390)
--------- --------- ---------
Increase (decrease) in cash and cash
equivalents................................ (13,053) 8,506 11,152
Cash and cash equivalents, beginning of
period..................................... 20,416 11,910 758
--------- --------- ---------
Cash and cash equivalents, end of period.... $ 7,363 $ 20,416 $ 11,910
========= ========= =========
Supplemental Cash Flow Information:
Interest paid............................... $ 1,923 $ 1,398 $ 497
Income taxes paid........................... 13,242 9,374 7,275
Non-Cash Activities:
Issuance of notes payable in connection with
acquisition of subsidiary.................. $ -- $ 3,000 $ --
Assets acquired under capital lease......... -- -- 7,215
See notes to consolidated financial statements.
F-7
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except per share data)
1. Summary of Significant Accounting Policies
PC Connection, Inc. and subsidiaries (the "Company") is a direct marketer of
information technology products and solutions, including brand-name personal
computers and related peripherals, software, and networking products to
business, education, government, and consumer end users located primarily in
the United States. The following is a summary of significant accounting
policies.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of PC Connection,
Inc. and subsidiaries. Intercompany transactions and balances are eliminated in
consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions. These estimates and assumptions
affect the amounts reported in the accompanying consolidated financial
statements. Actual results could differ from those estimates.
Revenue Recognition
Revenue on product sales is recognized at the point in time when persuasive
evidence of an arrangement exists, the price is fixed and final, delivery has
occurred and there is a reasonable assurance of collection of the sales
proceeds. The Company generally obtains oral or written purchase authorizations
from its customers for a specified amount of product at a specified price and
considers delivery to have occurred at the point of shipment. The Company
provides its customers with a limited thirty day right of return only for
defective merchandise. Revenue is recognized at shipment and a reserve for
sales returns is recorded. The Company has demonstrated the ability to make
reasonable and reliable estimates of product returns in accordance with SFAS
No. 48 based on significant historical experience.
Cash and Cash Equivalents
The Company considers all highly liquid short-term investments with original
maturities of 90 days or less to be cash equivalents. The carrying value of the
Company's cash equivalents approximates fair value.
Inventories--Merchandise
Inventories (all finished goods) consisting of software packages, computer
systems and peripheral equipment, are stated at cost (determined under the
first-in, first-out method) or market, whichever is lower. Provisions are made
currently for obsolete, slow moving and nonsalable inventory.
Advertising Costs and Revenues
Costs of producing and distributing catalogs are deferred and charged to
expense over the period that each catalog remains the most current selling
vehicle (generally one to two months) which approximate the period of probable
benefits. Other advertising costs are expensed as incurred. Vendors have the
ability to place advertisements in the catalogs for which the Company receives
advertising allowances and incentives. These revenues are recognized on the
same basis as the catalog costs.
F-8
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Advertising costs charged to expense were $27,159, $31,487 and $32,498 for
the years ended December 31, 2000, 1999 and 1998, respectively. Deferred
advertising revenues at December 31, 2000, 1999 and 1998 exceeded deferred
advertising costs by $110, $423 and $325 at those respective dates.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization is
provided for both financial and income tax reporting purposes over the
estimated useful lives of the assets ranging from three to seven years.
Computer software, including licenses and internally developed software, is
capitalized and amortized over lives ranging from three to five years.
Depreciation is and has been provided using accelerated methods for property
acquired prior to 1996 and on the straight-line method for property acquired
thereafter. Leasehold improvements and facilities under capital leases are
amortized over the terms of the related leases or their useful lives, whichever
is shorter, whereas for income tax reporting purposes, they are amortized over
the applicable tax lives. The Company periodically evaluates the carrying value
of property and equipment based upon current and anticipated undiscounted cash
flows, and recognizes an impairment when it is probable that such estimated
future cash flows will be less than the asset carrying value.
Goodwill
Goodwill arises from certain purchase transactions and is amortized using
the straight-line method over appropriate periods not exceeding 15 years. The
amount charged to expense during 2000 and 1999 was $704 and $324, respectively.
In certain situations, specifically those where the goodwill is associated with
other assets that are subject to impairment losses, goodwill impairment is
assessed relative to undiscounted cash flows. In other situations where
goodwill is considered to be associated with the entire enterprise, impairment
is assessed based on undiscounted enterprise cash flows.
Tax Status and Income Taxes
For periods prior to March 6, 1998, the Company elected to be treated as an
S Corporation under Subchapter S of the Internal Revenue Code (the "Code"), and
applicable state laws. Effective with the consummation of the Company's initial
public offering of its common stock on March 6, 1998 (the "Offering"), the
Company's S Corporation election was automatically terminated and the Company
became subject to federal and state income taxes as a C Corporation from that
date forward.
Deferred income tax assets and liabilities are computed for differences
between the financial statement and tax basis of assets and liabilities that
will result in taxable or deductible amounts in the future, based on enacted
tax laws and rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount that is more likely than
not to be realized. "Income taxes" as presented on the Consolidated Statements
of Income comprise the tax payable or refundable for the period plus or minus
the change during the period in deferred tax assets and liabilities.
Additional Stockholder/Officer Compensation
Additional stockholder/officer compensation represents amounts accrued or
distributed in excess of aggregate annual base salaries approved by the Board
of Directors (the "Board") and generally represents Company-related federal
income tax obligations payable by the stockholders for period during which the
Company was an S Corporation.
F-9
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Concentration of Credit Risk
Concentrations of credit risk with respect to trade account receivables are
limited due to the large number of customers comprising the Company's customer
base. Ongoing credit evaluations of customers' financial condition are
performed.
Earnings Per Share
Basic earnings per common share is computed using the weighted average
number of shares outstanding. Diluted earnings per share is computed using the
weighted average number of shares outstanding adjusted, when dilutive, for the
incremental shares attributed to outstanding options to purchase common stock.
The denominator for pro forma basic earnings per share for the period prior to
March 6, 1998 includes the weighted average shares required to pay the S
Corporation dividend (assuming a price per share of $11.67 for the year ended
December 31, 1998).
The following table sets forth the computation of basic and diluted earnings
per share:
Pro Forma
2000 1999 1998
------- ------- ---------
(amounts in thousands,
except per share data)
Numerator:
Net income......................................... $31,463 $22,730 $13,828
Denominator:
Denominator for basic earnings per share:
Weighted average shares.......................... 24,054 23,475 22,274
Weighted average shares required to pay
stockholder dividend............................ -- -- 474
------- ------- -------
Denominator for basic earnings per share........... 24,054 23,475 22,748
------- ------- -------
Effect of dilutive securities:
Employee stock options............................. 1,518 692 756
------- ------- -------
Denominator for diluted earnings per share........... 25,572 24,167 23,504
======= ======= =======
Earnings per share:
Basic.............................................. $ 1.31 $ .97 $ .61
======= ======= =======
Diluted............................................ $ 1.23 $ .94 $ .59
======= ======= =======
The above pro forma adjustment has been made to the historical results of
operations for the period from January 1 through March 5, 1998 to make the pro
forma presentation comparable to what would have been reported had the Company
operated as a C Corporation. The computation of income tax expense was made
assuming an effective tax rate of approximately 39%.
The following options to purchase Common Stock were excluded from the
computation of diluted earnings per share for years ended December 31, 2000,
1999, and 1998 because the effect of the options on the calculation would have
been anti-dilutive:
2000 1999 1998
---- ---- ----
Anti-dilutive stock options................................... 97 -- 117
F-10
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Stock-Based Compensation
Compensation expense associated with awards of stock or options to employees
and directors is measured using the intrinsic value method in accordance with
APB Opinion No. 25. The Board estimated the fair value of the Company's stock
for awards made prior to the Offering using market valuations of comparable
publicly traded companies, among other factors.
Comprehensive Income
The Company has no other comprehensive income in any of the periods
presented. Accordingly, a separate statement of comprehensive income is not
presented.
Recently Issued Financial Accounting Pronouncements
In June 1998 the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
133") adjusted to be effective for fiscal years beginning after June 15, 2000.
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. Under SFAS 133, certain contracts that
were not formerly considered derivatives may now meet the definition of a
derivative. The Company adopted SFAS 133 effective January 1, 2001. The
adoption of SFAS 133 did not have a significant impact on the financial
position or results of operations of the Company.
In December 1999 the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements." This SAB clarifies certain elements of revenue recognition. Since
December 1999, the SEC has issued several amendments that postponed the
implementation date to the fourth quarter of fiscal 2000. Implementation of the
SAB did not have a material impact on the Company's consolidated financial
statements.
In July 2000, the Emerging Issues Task Force reached a consensus on Issue
00-10, "Accounting for Shipping and Handling Fees and Costs". The Consensus
specifically stated that all amounts billed to a customer in a sale transaction
related to shipping and handling, if any, represent revenues earned for the
goods provided and should be classified as revenue. It was previously the
Company's policy to record such revenues as a reduction of cost of goods sold.
The Company adopted this Consensus in the fourth quarter of fiscal 2000. All
net sales amounts and gross margin percentages reflect the reclassification of
amounts billed to customers in sales transactions related to shipping and
handling as revenue.
Reclassifications
Certain amounts in the 1999 and 1998 financial statements have been
reclassified to conform to the 2000 presentation.
2. Acquisitions
On January 4, 2000 the Company acquired the Merisel Americas Inc. call
center in Marlborough, Massachusetts for approximately $2,200 including
acquisition costs. The Company acquired the assembled work force of Merisel, as
well as its fixed assets; it also assumed its lease liabilities. The excess of
the purchase price over the fair value of the assets acquired totaled
approximately $1,300. Such excess will be amortized over a period of 15 years.
F-11
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
On June 29, 1999, the Company acquired all of the outstanding stock of
ComTeq Federal, Inc., a supplier of computer equipment and services to federal
government agencies. The purchase price was $8,300, including acquisition costs
and consisted of cash of $5,300 and promissory notes aggregating $3,000. Total
cash paid for ComTeq Federal Inc., net of cash acquired, was $3,200. The
transaction has been accounted for by the purchase method, and accordingly, the
results of operations for the period from June 29, 1999 are included in the
accompanying financial statements. The assets purchased and liabilities assumed
have been recorded at their fair value at the date of acquisition. The excess
of the purchase price, including acquisition costs, over the fair value of the
liabilities assumed has been recorded as goodwill (approximately $9,700).
Goodwill will be amortized over a period of 15 years. The promissory notes are
unsecured, bear interest at the prime rate less 0.5% and are scheduled to be
repaid over a three year period. As of December 31, 2000, the short-term
portion of the promissory notes was $1,000 and the long-term portion was
$1,000.
Pro Forma Information
The following unaudited pro forma information presents the consolidated
results of operations of the Company as if the acquisition of ComTeq Federal,
Inc. had taken place as of the beginning of each of the periods presented.
Merisel results prior to the acquisition have not been included because of
their immateriality.
Years Ended December 31,
--------------------------
1999 1998
------------- ------------
(in thousands except
per share data)
Revenues.......................................... $ 1,105,664 $ 787,102
Net income........................................ 23,350 14,647
Diluted earnings per share........................ .97 .62
3. Accounts Receivable
Accounts receivable consisted of the following:
December 31,
-----------------
2000 1999
-------- -------
Trade.................................................... $134,682 $96,981
Co-op advertising........................................ 4,243 2,965
Vendor returns, rebates and other........................ 9,847 7,109
-------- -------
Total.................................................. 148,772 107,055
Less allowances for:
Sales returns.......................................... (3,592) (3,717)
Doubtful accounts...................................... (5,536) (3,933)
-------- -------
Accounts receivable, net................................. $139,644 $99,405
======== =======
F-12
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
4. Property and Equipment
Property and equipment consisted of the following:
December 31,
----------------
2000 1999
------- -------
Facilities under capital lease........................... $ 7,215 $ 7,215
Leasehold improvements................................... 4,730 5,337
Furniture and equipment.................................. 25,711 22,923
Computer software, including licenses and internally-
developed software...................................... 18,645 10,749
Automobiles.............................................. 266 224
------- -------
Total.................................................. 56,567 46,448
Less accumulated depreciation and amortization........... (27,902) (23,322)
------- -------
Property and equipment, net.............................. $28,665 $23,126
======= =======
5. Bank Borrowings
At December 31, 2000, the Company had an unsecured credit agreement with a
bank providing for short-term borrowings up to $70,000 which bears interest at
various rates ranging from the prime rate (9.50% at December 31, 2000) to prime
rate less 1% depending on the ratio of senior debt to EBITDA (earnings before
interest, taxes, depreciation and amortization). The credit agreement includes
various customary financial and operating covenants, including minimum net
worth requirements, minimum net income requirements and restrictions on the
payment of dividends, none of which the Company believes significantly
restricts the Company's operations. No amounts were outstanding under this
facility at December 31, 2000. The credit agreement matures on May 31, 2002.
Certain information with respect to short-term borrowings were as follows:
Weighted Average Maximum Amount Average Amount
Interest Rate Outstanding Outstanding
---------------- -------------- --------------
Year ended December 31,
2000........................ 8.2% $55,000 $9,567
1999........................ 7.4 29,543 4,497
1998........................ 8.2 28,307 4,145
6. Trade Credit Arrangements
At December 31, 2000 and 1999, the Company had security agreements with two
financial institutions to facilitate the purchase of inventory from various
suppliers under certain terms and conditions. The agreements allow a
collateralized position in inventory financed by the financial institutions up
to an aggregated amount of $60,000. The cost of such financing under these
agreements is borne by the suppliers. At December 31, 2000 and 1999, accounts
payable included $12,136 and $31,064, respectively owed to these financial
institutions.
7. Capital Lease
In November 1997, the Company entered into a fifteen-year lease for a new
corporate headquarters with an affiliated company related to the Company
through common ownership. The Company occupied the facility upon completion of
construction in late November 1998, and the lease payments commenced in
December 1998. Annual lease payments under the terms of the lease, as amended,
are approximately $911 for the first five
F-13
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
years of the lease, increasing to $1,025 for years six through ten and $1,139
for years eleven through fifteen. The lease requires the Company to pay its
proportionate share of real estate taxes and common area maintenance charges as
additional rent and also to pay insurance premiums for the leased property. The
Company has the option to renew the lease for two additional terms of five
years each. The lease has been recorded as a capital lease.
Future aggregate minimum annual lease payments under this lease at December
31, 2000 are as follows:
Year Ending December 31 Payments
----------------------- --------
2001.............................................................. $ 911
2002.............................................................. 911
2003.............................................................. 921
2004.............................................................. 1,025
2005.............................................................. 1,025
2006 and thereafter............................................... 8,688
-------
Total minimum payments (excluding taxes, maintenance and
insurance)....................................................... 13,481
Less amount representing interest................................. (6,536)
-------
Present value of minimum lease payments........................... 6,945
Less current maturities........................................... (153)
-------
Long-term portion................................................. $ 6,792
=======
8. Stockholders' Equity
Formation of Holding Company
On January 1, 2000, the Company formed a new holding company structure to
support PC Connection's future growth and plans to expand its current business
lines through internal growth and potential acquisitions.
Outstanding shares of common stock representing interests in PC Connection
prior to the holding company formation were converted into shares of the new
holding company on a one-for-one basis through a non-taxable transaction.
Common stock shares of the new holding company trade on the Nasdaq National
Market under the symbol, "PCCC", the same exchange and symbol used by the
predecessor company. The new shares hold the same voting power that shares of
the predecessor held. No additional capital stock was issued as part of the
transaction. The directors and officers of the predecessor company serve as the
directors and officers of the new holding company.
Stock Split
In April 2000, the Company's Board of Directors approved a three-for-two
stock split of its outstanding shares of Common Stock to be effected in the
form of a 50% stock dividend. The dividend was distributed on May 23, 2000 to
the Company's stockholders of record as of the close of business on May 12,
2000. All per share and related amounts contained in these financial statements
and notes have been adjusted retroactively to reflect the stock split.
F-14
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Preferred Stock
The Amended and Restated Certificate of Incorporation of the Delaware
Corporation (the "Restated Certificate") authorized the issuance of up to
7,500,000 shares of preferred stock, $.01 par value per share (the "Preferred
Stock"). Under the terms of the Restated Certificate, the Board is authorized,
subject to any limitations prescribed by law, without stockholder approval, to
issue by a unanimous vote such shares of Preferred Stock in one or more series.
Each such series of Preferred Stock shall have such rights, preferences,
privileges and restrictions, including voting rights, dividend rights,
redemption privileges and liquidation preferences, as shall be determined by
the Board. There were no preferred shares outstanding at 2000 and 1999.
Incentive and Non-Statutory Stock Option Plans
In December 1993, the Board adopted and the stockholders approved the 1993
Incentive and Non-Statutory Stock Option Plan (the "1993 Plan"). Under the
terms of the 1993 Plan, the Company is authorized to make awards of restricted
stock and to grant incentive and non-statutory options to employees of, and
consultants and advisors to, the Company to purchase shares of the Company's
stock. A total of 1,686,245 shares of the Company's Common Stock was authorized
for issuance upon exercise of options granted or awards made under the 1993
Plan. Options vest over varying periods up to four years and have contractual
lives up to ten years.
In November 1997, the Board adopted and the stockholders approved the 1997
Stock Incentive Plan (the "1997 Plan"), which became effective on the closing
of the Offering. The 1997 Plan provides for the grant of incentive stock
options, non-statutory stock options, stock appreciation rights, performance
shares and awards of restricted stock and unrestricted stock. A total of
3,000,000 shares have been reserved for issuance under this Plan.
Information regarding the 1993 and 1997 Plans is as follows:
Weighted
Average Weighted
Option Exercise Average
Shares Price Fair Value
--------- -------- ----------
Outstanding, December 31, 1997............... 1,641,015 $ 2.21
Granted.................................... 1,170,545 11.85 5.41
Exercised.................................. (318,972) .70
Forfeited.................................. (84,233) 5.11
---------
Outstanding, December 31, 1998............... 2,408,355 7.02
Granted.................................... 714,832 10.36 4.29
Exercised.................................. (175,903) 4.62
Forfeited.................................. (124,674) 9.02
---------
Outstanding, December 31, 1999............... 2,822,610 7.93
---------
Granted.................................... 626,415 30.27 15.78
Exercised.................................. (687,653) 5.56
Forfeited.................................. (111,864) 13.35
---------
Outstanding, December 31, 2000............... 2,649,508 13.61
=========
F-15
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
The following table summarizes the status of outstanding stock options as of
December 31, 2000:
Options Outstanding Options Exercisable
------------------------------------- ------------------------
Weighted
Average Weighted Weighted
Exercise No. of Remaining Average No. of Average
Price Range Shares Life (Years) Exercise Price Shares Exercise Price
----------- --------- ------------ -------------- --------- --------------
$.51 257,893 3.11 $ .51 257,893 $ .51
$.51-$2.54 96,294 4.96 1.30 91,378 1.52
$3.81 211,433 5.13 3.81 177,504 3.81
$8.92 343,454 8.73 8.92 62,611 8.92
$9.98 10,000 9.96 9.98 0 0
$11.33 3,750 8.10 11.33 0 0
$11.67 1,037,090 6.48 11.67 598,503 11.67
$11.83-$16.83 102,516 7.87 13.53 11,767 13.56
$18.33 251,076 9.06 18.33 0 0
$20.33-$20.58 67,500 9.07 20.56 1,875 20.33
$25.25 48,000 9.80 25.25 0 0
$27.25-$50.00 20,000 9.52 34.67 0 0
$51.81 182,502 9.54 51.81 0 0
$52.75-$62.19 18,000 9.64 53.54 0 0
- ------------- --------- ---- ------ --------- ------
$.51-$62.19 2,649,508 6.97 $13.61 1,201,531 $ 7.21
============= ========= ==== ====== ========= ======
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation". Accordingly, compensation expense
for options awarded under the Plans in 2000, 1999 and 1998, has been recognized
using the intrinsic value method.
The fair value of options granted prior to the consummation of the Offering
was estimated using the minimum value method and risk-free interest rates and
expected option lives of 6% and seven years, respectively. The minimum value
pricing method was designed to value stock options of non-public companies;
accordingly, the minimum value method assumed zero volatility.
The Black-Scholes model was used to value options granted subsequent to the
Offering using a volatility factor of 69%, 50%, and 50% for 2000, 1999 and
1998, respectively, estimated option lives of four years, and a risk-free
interest rate of 6.4% for 2000 and 6.0% for 1999 and 1998, respectively.
Management believes that the assumptions used and the models applied to value
the awards yield a reasonable estimate of the fair value of the grants made
under the circumstances, given the alternatives under SFAS No. 123.
Effective upon the consummation of the Offering, certain restrictions as to
the exercise of options granted under the Company's 1993 Plan expired. Prior to
the consummation of the Offering, the Company recorded compensation expense for
certain options granted at prices less than their fair market value ratably
over seven years from the dates granted, because such options were not
exercisable except upon the occurrence of certain events, including a public
offering of the Company's Common Stock. Effective upon the consummation of the
Offering, the Company recorded a one-time charge for stock-option compensation
expense of approximately $870, relating to the acceleration of the vesting
period of certain of the Company's stock options from seven to four years.
F-16
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Compensation expense charged to operations using the intrinsic value method
totaled $51, $162 and $1,297 (including the one-time charge of $870 referred to
above), for the years ended December 31, 2000, 1999, and 1998, respectively.
Had the Company recorded compensation expense using the fair value method under
SFAS No. 123, pro forma net income and diluted net income per share for the
years ended December 31 would have been as follows:
Pro
Forma
------- ------- -------
2000 1999 1998
------- ------- -------
Net income, as reported............................. $31,463 $22,730 $13,828
Net income, under SFAS No. 123...................... 29,414 21,511 12,979
Diluted net income per share, as reported........... 1.23 .94 .59
Diluted net income, under SFAS No. 123.............. 1.15 .89 .55
1997 Employee Stock Purchase Plan
In November 1997, the Board adopted and the stockholders approved the 1997
Employee Stock Purchase Plan (the "Purchase Plan"), which became effective on
February 1, 1999. The Purchase Plan authorizes the issuance of Common Stock to
participating employees. Under the terms of the Purchase Plan, the purchase
price is an amount equal to 85% of the fair market value per share of the
Common Stock on either the first day or the last day of the offering period,
whichever is lower. An aggregate of 337,500 shares of Common Stock has been
reserved for issuance under the Purchase Plan, of which 145,000 shares were
purchased.
9. Income Taxes
The provision for income taxes prior to March 6, 1998 was based on the state
income tax obligations of the Company as an S Corporation. Effective with the
consummation of the Offering, the Company's S Corporation election was
terminated and the Company began to account for income taxes as a C
Corporation.
The 2000, 1999 and 1998 provision for income taxes and unaudited 1998 pro
forma provision for income taxes consisted of the following:
Years Ended December 31,
-------------------------------
(Pro
Forma)
2000 1999 1998 1998
------- ------- ------- ------
Paid or currently payable:
Federal...................................... $16,673 $10,373 $ 6,390 $6,882
State........................................ 1,526 1,409 842 680
------- ------- ------- ------
Total current.............................. 18,199 11,782 7,232 7,562
------- ------- ------- ------
Deferred:
Recognition of deferred tax asset upon
termination of S Corporation election....... -- -- (4,200) --
Federal...................................... 1,004 1,983 795 1,054
State........................................ 86 170 78 105
------- ------- ------- ------
Net deferred............................... 1,090 2,153 (3,327) 1,159
------- ------- ------- ------
Net provision.............................. $19,289 $13,935 $ 3,905 $8,721
======= ======= ======= ======
F-17
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
The components of the deferred taxes at December 31, 2000 and 1999 are as
follows:
2000 1999
------- -------
Current:
Provisions for doubtful accounts........................... $ 2,104 $ 1,456
Inventory costs capitalized for tax purposes............... 442 519
Inventory and sales returns reserves....................... 887 1,221
Deductible expenses, primarily employee-benefit related.... 61 114
Other liabilities.......................................... (1,319) (1,319)
------- -------
Net deferred tax asset................................... 2,175 1,991
------- -------
Non-Current:
Compensation under non-statutory stock option agreements... 426 670
Excess of book basis over tax basis of property and
equipment................................................. (3,981) (2,249)
------- -------
Net deferred tax liability............................... (3,555) (1,579)
------- -------
Net deferred tax asset (liability)......................... $(1,380) $ 412
======= =======
The reconciliation of the Company's 2000, 1999 and 1998 income tax provision
and its 1998 unaudited pro forma income tax provision to the statutory federal
tax rate is as follows:
(Pro Forma)
---- ---- ----- -----------
2000 1999 1998 1998
---- ---- ----- -----------
Statutory tax rate............................. 35.0% 35.0% 35.0% 35.0%
Recognition of deferred tax asset upon
termination of S Corporation election......... -- -- (18.6) --
1998 S Corporation income not subject to
federal income taxes.......................... -- -- (2.8) --
State income taxes, net of federal benefit..... 2.5 2.6 2.6 2.6
Nondeductible expenses......................... 0.4 0.2 0.2 0.2
Other--net..................................... 0.1 0.2 0.9 0.9
---- ---- ----- ----
Effective income tax rate...................... 38.0% 38.0% 17.3% 38.7%
==== ==== ===== ====
10. Employee Benefit Plan
The Company has a contributory profit-sharing and employee savings plan
covering all qualified employees. No contributions to the profit-sharing
element of the plan were made by the Company in 2000, 1999 or 1998. The Company
made matching contributions to the employee savings element of the plan of
approximately $592, $317 and $361 in 2000, 1999 and 1998, respectively.
11. Commitments and Contingencies
Operating Leases
The Company leases certain office facilities from its principal stockholders
under 20-year noncancelable operating leases. The lease agreement for one
facility requires the Company to pay all real estate taxes and insurance
premiums related thereto. The Company also leases several other buildings from
its principal stockholders on a month-to-month basis.
In addition, the Company leases office and distribution facilities and
equipment from unrelated parties with remaining terms of one to six years.
F-18
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Future aggregate minimum annual lease payments under these leases at
December 31, 2000 are as follows:
Year Ending December 31 Related Parties Others Total
----------------------- --------------- ------ -----
2001........................................ $179 $4,968 $5,147
2002........................................ 149 3,434 3,583
2003........................................ 134 1,609 1,743
2004........................................ 134 592 726
2005........................................ 134 246 380
2006 and thereafter......................... 338 12 350
Total rent expense aggregated $3,936, $1,470 and $1,521 for the years ended
December 31, 2000, 1999 and 1998, respectively, under the terms of the leases
described above. Such amounts included $169, $189 and $327 in 2000, 1999 and
1998, respectively, paid to related parties.
Contingencies
The Company is subject to various legal proceedings and claims which have
arisen during the ordinary course of business. In the opinion of management,
the outcome of such matters is not expected to have a material effect on the
Company's financial position, results of operations and cash flows.
12. Other Related Party Transactions
Other related-party transactions include the transactions summarized below.
Related parties consist primarily of affiliated companies related to the
Company through common ownership.
Year Ended
December 31,
--------------
2000 1999 1998
---- ---- ----
Revenue:
Sales of various products...................................... $ 3 $ 1 $13
Sales of services to affiliated companies...................... 300 332 --
Costs:
Purchase of services from affiliated companies................. 9 6 2
13. Segment and Related Disclosures
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," requires that public companies report profits and losses and
certain other information on its "reportable operating segments" in its annual
and interim financial statements.
Management has determined that the Company has only one "reportable
operating segment," given the financial information provided to and used by
the "chief decision maker" of the Company to allocate resources and assess the
Company's performance. However, senior management does monitor revenue by
platform (PC vs. Mac), sales channel (Inbound Telesales, Corporate Outbound,
On-line Internet), and product mix (Notebooks, Desktops and Servers, Storage
Devices, Software, Networking Communications, Printers, Video and Monitors,
Memory, Accessories and Other).
F-19
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
Net sales by platform, sales channel, and product mix are presented below:
Year Ended December 31,
------------------------------
2000 1999 1998
---------- ---------- --------
Platform
PC and Multi Platform......................... $1,300,453 $ 919,543 $604,635
Mac........................................... 149,455 161,292 145,270
---------- ---------- --------
Total....................................... $1,449,908 $1,080,835 $749,905
========== ========== ========
Sales Channel
Corporate Outbound............................ $1,099,879 $ 705,580 $398,948
Inbound Telesales............................. 237,013 314,622 320,847
On-Line Internet.............................. 113,016 60,633 30,110
---------- ---------- --------
Total....................................... $1,449,908 $1,080,835 $749,905
========== ========== ========
Product Mix
Notebooks..................................... $ 365,067 $ 250,801 $149,738
Desktop/Servers............................... 211,505 165,325 117,196
Storage Devices............................... 139,406 109,675 82,189
Software...................................... 149,982 129,484 107,493
Networking Communications..................... 113,022 69,065 43,940
Printers...................................... 103,125 99,287 59,986
Video & Monitors.............................. 117,602 81,805 58,263
Memory........................................ 58,465 38,318 28,802
Accessories/Other............................. 191,734 137,075 102,298
---------- ---------- --------
Total....................................... $1,449,908 $1,080,835 $749,905
========== ========== ========
Included in the product mix sales are enterprise networking product sales of
$253,000, $125,000 and $55,000 for the years ended December 2000, 1999 and
1998, respectively.
Substantially, all of the Company's net sales in 2000, 1999 and 1998 were
made to customers located in the United States. Shipments to customers located
in foreign countries aggregated less than 2% in 2000, 1999 and 1998. All of the
Company's assets at December 31, 2000 and 1999 were located in the United
States. The Company's primary target customers are small- to medium-size
businesses ("SMBs") comprised of 20 to 1,000 employees, although its customers
also include individual consumers, larger companies, federal, state and local
governmental agencies and educational institutions. No single customer other
than federal government accounted for more than 3% of total net sales in 2000.
Net sales to the federal government in 2000 and 1999 were $129,200 or 8.9% of
total net sales and $81,400 or 7.7% of total net sales, respectively. No single
customer (including the federal government) accounted for more than 1% of total
net sales in 1998.
14. Selected Unaudited Quarterly Financial Results
The following table sets forth certain unaudited quarterly data of the
Company for each of the quarters since January 1999. This information has been
prepared on the same basis as the annual financial statements and all necessary
adjustments, consisting only of normal recurring adjustments, have been
included in the amounts stated below to present fairly the selected quarterly
information when read in conjunction with the annual financial statements and
the notes thereto included elsewhere in this document. The quarterly operating
F-20
PC CONNECTION, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(amounts in thousands, except per share data)
results are not necessarily indicative of future results of operations. See
"Factors That May Affect Future Results and Financial Condition--Historical Net
Losses; Variability of Quarterly Results."
Quarters Ended
---------------------------------------
March 31, June 30, Sept. Dec. 31,
2000 2000 30, 2000 2000
--------- -------- -------- --------
(in thousands, except per share
data)
Net sales............................ $333,799 $366,090 $404,876 $345,143
Cost of sales........................ 293,169 321,145 355,146 304,227
-------- -------- -------- --------
Gross profit........................ 40,630 44,945 49,730 40,916
Selling, general and administrative
expenses............................ 29,007 30,903 32,872 31,190
-------- -------- -------- --------
Income from operations.............. 11,623 14,042 16,858 9,726
Interest expense..................... (340) (334) (440) (972)
Other, net........................... 204 165 121 99
-------- -------- -------- --------
Income before income taxes........... 11,487 13,873 16,539 8,853
Income tax provision................. (4,368) (5,272) (6,284) (3,365)
-------- -------- -------- --------
Net Income.......................... $ 7,119 $ 8,601 $ 10,255 $ 5,488
======== ======== ======== ========
Weighted average common shares
outstanding:
Basic............................... 23,676 23,926 24,243 24,364
======== ======== ======== ========
Diluted............................. 24,879 25,556 25,897 25,471
======== ======== ======== ========
Earnings per common share:
Basic............................... $ .30 $ .36 $ .42 $ .23
======== ======== ======== ========
Diluted............................. $ .29 $ .34 $ .40 $ .22
======== ======== ======== ========
Quarters Ended
---------------------------------------
March 31, June 30, Sept. Dec. 31,
1999 1999 30, 1999 1999
--------- -------- -------- --------
(in thousands, except per share
data)
Net sales............................ $230,633 $237,456 $288,176 $324,570
Cost of sales........................ 203,567 209,657 253,724 284,541
-------- -------- -------- --------
Gross profit........................ 27,066 27,799 34,452 40,029
Selling, general and administrative
expenses............................ 19,763 20,040 24,333 27,269
-------- -------- -------- --------
Income from operations.............. 7,303 7,759 10,119 12,760
Interest expense..................... (266) (276) (449) (401)
Other, net........................... 94 47 32 (57)
-------- -------- -------- --------
Income before income taxes........... 7,131 7,530 9,702 12,302
Income tax provision................. (2,710) (2,862) (3,687) (4,676)
-------- -------- -------- --------
Net Income.......................... $ 4,421 $ 4,668 $ 6,015 $ 7,626
======== ======== ======== ========
Weighted average common shares
outstanding:
Basic............................... 23,433 23,441 23,477 23,546
======== ======== ======== ========
Diluted............................. 24,102 24,092 24,117 24,683
======== ======== ======== ========
Earnings per common share:
Basic............................... $ .19 $ .20 $ .26 $ .32
======== ======== ======== ========
Diluted............................. $ .18 $ .19 $ .25 $ .31
======== ======== ======== ========
F-21
PC CONNECTION, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(amounts in thousands)
Balance at Charged to Balance at
Beginning Costs and Deductions- End of
Description of Period Expenses Write-Offs Period
----------- ---------- ---------- ----------- ----------
Allowance for Sales Returns
Year Ended December 31, 1998.... $2,701 $70,434 $(69,105) $4,030
Year Ended December 31, 1999.... 4,030 68,215 (68,528) 3,717
Year Ended December 31, 2000.... 3,717 67,321 (67,446) 3,592
Allowance for Doubtful Accounts
Year Ended December 31, 1998.... 2,659 6,296(1) (3,834) 5,121
Year Ended December 31, 1999.... 5,121 6,821(1) (8,009) 3,933
Year Ended December 31, 2000.... 3,933 9,868(1) (8,265) 5,536
Inventory Valuation Reserve
Year Ended December 31, 1998.... 1,896 6,017 (5,323) 2,590
Year Ended December 31, 1999.... 2,590 5,350 (6,099) 1,841
Year Ended December 31, 2000.... 1,841 5,651 (5,792) 1,700
- --------
(1) Additions to the provision for doubtful accounts include charges to
advertising and cost of sales aggregating $2,863, $1,037 and $3,063 for the
years ended December 31, 2000, 1999, and 1998, respectively. Such
allowances relate to receivables under cooperative arrangements with
vendors.
S-1