FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended September 30, 1996 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _______ to ______ Commission file number 0-25790 CREATIVE COMPUTERS, INC. (Exact name of registrant as specified in its charter) Delaware 95-4518700 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 2645 Maricopa Street Torrance, California 90503 (address of principal executive offices) (310) 787-4500 (Registrant's telephone number, including area code) Indicated 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 __________ --------- There were 9,774,076 outstanding shares of COMMON STOCK at November 12, 1996. CREATIVE COMPUTERS, INC. INDEX TO FORM 10-Q PART I - FINANCIAL INFORMATION PAGE Item 1 - Financial Statements Consolidated Balance Sheet.................................................. 2 Consolidated Statement of Operations........................................ 3 Consolidated Statement of Cash Flows........................................ 4 Condensed Notes to the Consolidated Financial Statements.................... 5 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 6 PART II - OTHER INFORMATION................................................. 10 SIGNATURE................................................................... 11 1 CREATIVE COMPUTERS, INC. CONSOLIDATED BALANCE SHEET (IN THOUSANDS) SEPTEMBER 30, 1996 DECEMBER 31, 1995 (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 19,626 $ 13,082 Securities available for sale 4,097 12,575 Accounts receivable, net of allowance for doubtful accounts 16,574 18,305 Inventories 46,547 52,026 Prepaid expenses and other current assets 4,058 4,231 Deferred income taxes 4,421 1,109 -------- -------- Total current assets 95,323 101,328 Property, plant and equipment, net 11,012 10,814 Deferred income taxes 2,119 ---- Other assets 190 427 -------- -------- $108,644 $112,569 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 44,180 $ 46,098 Accrued expenses and other current liabilities 12,336 8,642 Capital leases - current portion 245 250 Notes payable - current portion 37 31 -------- -------- Total current liabilities 56,798 55,021 Capital leases 354 535 Notes payable 45 54 Deferred income taxes ---- 399 -------- -------- Total liabilities 57,197 56,009 -------- -------- Stockholders' equity: Common stock, $.001 par value; 15,000,000 shares authorized; 9,774,945 and 9,750,000 shares issued 10 10 Preferred stock, $.001 par value; 5,000,000 shares authorized; none issued and outstanding Additional paid in capital 53,845 51,547 Treasury stock, at cost; 15,000 shares (91) ---- Retained earnings (deficit) (2,317) 5,003 -------- -------- Total stockholders' equity 51,447 56,560 -------- -------- $108,644 $112,569 ======== ======== See condensed notes to consolidated financial statements. 2 CREATIVE COMPUTERS, INC. CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED, IN THOUSANDS EXCEPT PER SHARE DATA) FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1996 1995 1996 1995 Net sales $111,291 $119,546 $314,989 $290,354 Cost of goods sold 97,321 103,562 281,355 250,186 -------- -------- -------- -------- Gross profit 13,970 15,984 33,634 40,168 Selling, general and administrative expenses 13,201 13,119 46,217 31,806 Cost associated with the relocation of the Company's distribution center --- 150 --- 150 -------- -------- -------- -------- Income (loss) from operations before interest and income taxes 769 2,715 (12,583) 8,212 Interest income 215 224 450 303 -------- -------- -------- -------- Income (loss) before income taxes 984 2,939 (12,133) 8,515 Provision (benefit) for income taxes 427 1,155 (4,813) 3,318 -------- -------- -------- -------- Net income (loss) $ 557 $ 1,784 $ (7,320) $ 5,197 ======== ======== ======== ======== Earnings (loss) per share $ 0.06 $ 0.19 $ (0.75) $ 0.60 ======== ======== ======== ======== Weighted average shares outstanding 9,882 9,633 9,764 8,639 -------- -------- -------- -------- See condensed notes to consolidated financial statements. 3 CREATIVE COMPUTERS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED, IN THOUSANDS) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 SEPTEMBER 30, 1995 Cash flows from operating activities: Net income (loss) $ (7,320) $ 5,197 Adjustments to reconcile net income (loss) to net cash (used in) operating activities: Depreciation and amortization 1,439 819 Loss on disposal of asset ---- 19 Increase in allowance for doubtful accounts 2,089 536 Increase in inventory reserves 5,579 615 Deferred income taxes (5,830) 607 Changes in operating assets and liabilities: Accounts receivable (358) (11,729) Inventories (100) (25,921) Prepaid expenses and other current assets 173 (3,269) Other assets 237 (353) Accounts payable (1,918) 11,752 Accrued expenses and other current liabilities 3,694 5,798 Income taxes payable ---- (1,082) -------- -------- Total adjustments 5,005 (22,208) -------- -------- Net cash used in operating activities (2,315) (17,011) -------- -------- Cash flows from investing activities: Purchases of securities available for sale (19,223) (15,649) Redemptions of securities available for sale 27,701 ---- Acquisition of property, plant and equipment (1,637) (6,382) Increase in related party notes receivable ---- (265) -------- -------- Net cash provided by (used in) investing activities 6,841 (22,296) -------- -------- Cash flows from financing activities: Payments on line of credit, net ---- (3,279) Payments under notes payable, net (3) (1,037) Payments under notes payable - related parties ---- (415) Proceeds from profits realized by Director in sale of stock 2,160 ---- Principal payments of obligations under capital leases (186) (874) Borrowings through subordinated debt ---- 2,000 Net proceeds from sale of common stock ---- 46,550 Purchase of treasury stock (91) ---- Proceeds from stock issued under stock option plans 138 ---- -------- -------- Net cash provided by financing activities 2,018 42,945 -------- -------- Net increase in cash and cash equivalents 6,544 3,638 Cash and cash equivalents: Beginning of the period 13,082 3,348 -------- -------- End of the period $ 19,626 $ 6,986 ======== ======== See condensed notes to consolidated financial statements. 4 CREATIVE COMPUTERS, INC. CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. FINANCIAL STATEMENTS The consolidated interim financial statements include the accounts of Creative Computers, Inc. (a Delaware corporation) and its wholly owned subsidiaries (the Company) and have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such regulations. Although the Company believes that the disclosures herein are adequate to make the information not misleading, these financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company's Annual Report on Form 10-K at December 31, 1995. In the opinion of management, the accompanying financial statements contain all adjustments necessary to present fairly the financial position of the Company at September 30, 1996 and 1995 and the results of operations and cash flows for the nine months ended September 30, 1996 and 1995. 2. HOLDING COMPANY TRANSACTION On February 22, 1995, the Company (a California corporation) became a wholly-owned subsidiary of Creative Computers, Inc., a newly formed Delaware corporation, by merger of a wholly-owned subsidiary of the newly formed Delaware corporation into the Company. In the merger, 10,000 shares of Common Stock of the Company outstanding prior to the merger were converted into 4,900,000 shares of Common Stock in the newly formed Delaware corporation. The accompanying financial statements have been retroactively adjusted to give effect to this transaction. 3. NET INCOME (LOSS) PER SHARE Net income (loss) per share is based upon the weighted average number of common shares and common share equivalents outstanding during each period, after retroactive adjustment for the Holding Company Transaction (Note 2). Common share equivalents include dilutive stock options and warrants, if any, using the treasury stock method. 4. CONVERSION OF STOCK WARRANT On April 1, 1995, the holder of the Company's subordinated debt exercised its warrant to purchase up to 30% of the equity of the Company for $5 million. The debt holder exercised the warrant by canceling the subordinated debt and reducing by $50,000 the amount of cash the Company was required to pay for interest accrued through the date of conversion. 5. PUBLIC STOCK OFFERINGS On April 3, 1995, the Company completed an initial public offering (the Offering) of 2,250,000 shares of common stock at an offering price of $17.00 per share. Net proceeds to the Company were $34,401,000, after deducting the underwriting discount and other costs associated with the Offering. In connection with the Offering, the Company purchased a retail store location previously owned by the Company's majority stockholders by repaying the indebtedness on the property of approximately $1,297,000, canceling related party notes receivable in the amount of $1,771,000, 5 making a payment of approximately $181,000 to the stockholders, and recording a payable to a related company for $251,000 which was paid in May 1995. The aggregate purchase price for the property was $3.5 million, an amount determined by the Board of Directors to be the current fair value of the property based on a recent appraisal. However, the property has been included in the Company's financial statements at the stockholders' historical cost of $1,823,000 which resulted in a reduction in the Company's retained earnings of $1,677,000. On August 23, 1995, the Company completed a follow-on offering for 2,300,000 shares of common stock, of which 500,000 shares were sold by the Company, at an offering price of $26.25 per share. Net proceeds to the Company were $12,149,000, after deducting the underwriting discount and other costs associated with this follow-on offering. 6. PROCEEDS FROM PROFITS REALIZED BY DIRECTOR IN THE SALE OF STOCK In June 1996, the Company recorded additional paid in capital in the amount of $2,160,000 which represents cash contributed to the Company associated with profits realized in the sale of stock by a Director due to Section 16(b) of the Securities Exchange Act of 1934. 7. UNUSUAL PERIOD END CHARGES During the quarter ended June 30, 1996, the Company analyzed inventory by category and age in conjunction with an analysis of market conditions including the uncertainties surrounding Apple in the first half of the year. As a result, the Company recorded write-downs of $3,700,000 of inventory including adjustments for slow-moving and excessive inventory, $1,600,000 for accounts receivable, and $1,700,000 for products returned to vendors for which the Company does not anticipate payment. During the quarter ended March 31, 1996, the Company experienced approximately $1,900,000 in losses due to theft and inventory shrinkage. A small portion of this total has been recovered from insurance. Customer fraudulent credit card charges and chargebacks also increased resulting in a charge of $1,300,000 during the quarter ended March 31, 1996. In addition , the Company was victimized by external credit card fraud, including two schemes investigated by the Secret Service and others investigated by law enforcement. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company began operations in 1987 with a single retail store and mail order operations conducted through advertisements in national magazines. The Company added an additional retail store in 1988, became an authorized Apple dealer in 1991, opened two additional retail stores in the second quarter of 1993 and relocated its original store in the fourth quarter of 1993. In May of 1993, the Company relocated its mail order/catalog operations to a central location in Torrance, CA. The Company shifted its principal distribution and marketing focus from retail stores to direct mail distribution and marketing. In March 1994, the Company received authorization from Apple to offer the full retail line of Apple products via direct mail. The Company distributed the first edition of its MacMall catalog in April 1994, the first edition of its PC Mall catalog in May 1995, and the first edition of its DataCom Mall catalog in January 1996. During the fourth quarter of 1995, the Company moved its distribution center from Torrance, CA to a new facility in Memphis, TN. This distribution center consists of 220,000 square feet, with an additional 105,000 square feet to be added on May 1, 1997. 6 Net sales of the Company are primarily derived from the sale of personal computer hardware, software, peripherals and accessories to individuals, home offices, small businesses and large corporations. The Company is dependent on sales of Apple computers and software and peripheral products used with Apple computers. Products manufactured by Apple represented approximately 27% of the Company's net sales for the quarter ended September 30, 1996 as compared to 44% for the comparable period of 1995. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 1995 Net sales for the quarter ended September 30, 1996 were $111.3 million, a 6.9% decrease over net sales of $119.5 million for the comparable quarter in 1995. Net sales for the quarter ended September 30, 1996 were up 17.7% over the second quarter of 1996. PC/Wintel sales increased 50% from $19.0 million last year to $28.4 million this year for the three months ended September 30, 1996. Apple and related sales decreased 17.6% to $82.9 million for the three months ended September 30, 1996 as compared with $100.5 million for the comparable period in the prior year primarily as a result of planned decrease in catalog circulation and shortages on certain CPU products. Mail order/catalog net sales reflected a decrease of 4.5%, from $102.3 million in the third quarter last year to $97.8 million for the quarter ended September 30, 1996. On a comparable basis (excluding DataCom) the Company's catalog circulation that impacted the quarter was approximately 10.5 million catalogs during the three months ended September 30, 1996. During the same period ended September 30, 1995, the number of catalogs was 11.7 million. Gross profit decreased by $2 million to $14.0 million for the quarter ended September 30, 1996 from $16.0 million in the third quarter of 1995. Gross profit as a percentage of net sales decreased to 12.6% for the third quarter of 1996 from 13.4% for the like period in 1995 primarily due to PC sales comprising a larger percentage of the business and stronger sales promotions. The Company shipped approximately 240,000 mail order/catalog orders during the three months ended September 30, 1996 as compared to 224,000 for the same period last year. The Company's average order size was $407 for the three months ended September 30, 1996 as compared to $457 for the same period in 1995. Selling, general and administrative (SG&A) expenses amounted to $13.2 million for the three months ended September 30, 1996 as compared to $13.1 million for the comparable period in the prior year. As a percentage of net sales, SG&A expenses increased to 11.9% for the quarter from 11.0% for the same quarter in 1995. Net advertising costs declined as a result of implementing a new marketing strategy while personnel costs increased as the Company continues to lay the foundation for future growth. Interest income for the three months ended September 30, 1996 decreased by $9,000 or 4.0%, to $215,000 compared to $224,000 for the comparable quarter in 1995. The decrease was due to a reduction in cash invested in securities available for sale. Net income decreased by $1.2 million to $0.6 million for the three months ended September 30, 1996 from $1.8 million for the same period last year. In comparison to the second quarter of 1996, net income improved from a loss of $(5.4) million in the second quarter to a profit of $0.6 million. NINE MONTHS ENDED SEPTEMBER 30, 1996 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 1995 Net sales increased by $24.6 million or 8.5% to $315.0 million in the nine months ended September 30, 1996 from $290.4 million in the nine months ended September 30, 1995. Net sales for the period increased primarily due to growth in PC sales, which generated sales of $65.9 million for the nine months ended September 30, 1996, compared with $22.9 million during the same period last year. Apple and related sales were $249.1 million for the nine months ended September 30, 1996 as compared with $267.5 million for the comparable period in the prior year. Mail order/catalog net sales reflected an increase of 7 13.1%, from $241.9 million for the nine months ended September 30, 1995 to $273.5 million for the nine months ended September 30, 1996. For comparative purposes (excluding DataCom) approximately 31.4 million catalogs were in circulation during the nine months ended September 30, 1996. During the same period ended September 30, 1995, the Company had approximately 22.8 million catalogs in circulation. Gross profit decreased by $6.5 million to $33.6 million for the nine months ended September 30, 1996 from $40.2 million in the same period of 1995. Gross profit as a percentage of net sales decreased to 10.7% for the nine months of 1996 compared to 13.8% for the nine months of 1995. The decrease in gross profit margin was primarily the result of write-downs during the second quarter of 1996 of $3.7 million for slow-moving and excessive inventory and $1.7 million for products returned to vendors for which the Company does not anticipate payment plus $1.9 million for theft and shrinkage of inventory in the first quarter of 1996. Selling, general and administrative (SG&A) expense increased by $14.4 million to $46.2 million for the nine months ended September 30, 1996 from $31.8 million for the comparable period in the prior year. The increase in SG&A was primarily the result of an increase in personnel costs which included strengthening of the Company's management team, an increase in advertising costs resulting from increased catalog circulation, operational inefficiencies in the first six months associated with the relocation of the Company's distribution center to Memphis, Tennessee from Torrance, California, along with a $2.0 million increase in the allowance for doubtful accounts. As a percent to net sales, SG&A expenses increased to 14.7% for the period as compared to 11.0% for the nine months of 1995. Interest income for the nine months ended September 30, 1996 increased by $147,000 or 48.5%, to $450,000 compared to $303,000 for the comparable quarter in 1995. The increase in interest income is a result of the investment of cash proceeds from the Company's stock offerings in April and August of 1995. LIQUIDITY AND CAPITAL RESOURCES The Company's primary capital need has been funding the working capital requirements created by its rapid growth in sales. Prior to April 1995, the Company's primary sources of financing have been borrowings from its stockholders, private investors and financial institutions. In April and August of 1995, the Company completed an initial public offering and a follow-on offering of its common stock which resulted in net proceeds to the Company of approximately $46.6 million. As of September 30, 1996, the Company had cash and short term investments of $23.7 million. Inventories decreased to $46.5 million at September 30, 1996 from $52.0 million at December 31, 1995. Accounts receivable decreased $1.7 million at September 30, 1996 to $16.6 million compared to $18.3 million at December 31, 1995, partially as a result of increasing the allowance for doubtful accounts by $2.0 million. During the nine months ended September 30, 1996, the Company's capital expenditures were $1.6 million primarily for distribution equipment and leasehold improvements for the Company's new Memphis distribution center. Capital expenditures for the comparable period of last year were $6.4 million. The Company's primary capital needs will continue to be the funding of its working capital requirements for anticipated sales growth. The Company has an existing credit facility of $50.0 million with a financial institution. At September 30, 1996, the Company had $12.3 million outstanding under this credit facility. The credit facility functions in lieu of a vendor trade payable for inventory purchases and is included in accounts payable. The revolving credit line is cancelable upon 30 days advance notice and does not bear interest if paid within 60 days of the date inventory is purchased. The credit facility is secured by substantially all of the Company's assets and contains certain covenants which require the Company to maintain a minimum level of tangible net worth. 8 In July 1996, the Company announced its plan to repurchase up to 1,000,000 shares of its Common Stock. The shares will be repurchased from time to time at prevailing market prices, through open market or negotiated transactions, depending upon market conditions. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that the Company will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as the Company's management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted. The Company will finance the repurchase plan with existing working capital. As of September 30, 1996, the Company has repurchased 15,000 shares. As part of its growth strategy, the Company may, in the future, acquire other companies in the same or complementary lines of business. Any such acquisition and the ensuing integration of the operations of the acquired company would place additional demands on the Company's management and operating and financial resources. The Company from time to time engages in evaluation of and discussions with third parties regarding potential acquisitions and from time to time has submitted, and may in the future submit, proposals with respect to such potential acquisitions. The Company currently has no definitive agreements with respect to any such acquisitions. INFLATION Inflation has not had a material impact upon operating results, and the Company does not expect it to have such an impact in the near future. There can be no assurances, however, that the Company's business will not be so affected by inflation. BUSINESS FACTORS Except for historical information, all of the statements, expectations and assumptions contained in this report are forward looking statements. The realization of any or all of these expectations and assumptions is subject to a number of risks and uncertainties, and it is possible that the assumptions made by management may not materialize. In addition to the factors set forth above, other important factors that could cause actual results to differ materially from our expectations include competition from other catalog and retail store resellers and price pressures related thereto; uncertainties surrounding the supply of and demand for products manufactured by and compatible with Apple Computer and clones thereof; and the Company's reliance on major vendors and risks due to shifts in market demand and/or price erosion of owned inventory. This list of risk factors is not intended to be exhaustive. Reference should also be made to the risk factors set forth from time to time in the Company's SEC reports, including but not limited to its Annual Report on Form 10-K for 1995. 9 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibit 27 -- Financial Data Schedule (b) Reports on Form 8-K None. 10 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CREATIVE COMPUTERS, INC. Date: November 12, 1996 By /s/ Richard Finkbeiner ------------------------ RICHARD FINKBEINER Chief Financial Officer (Duly Authorized Officer of the Registrant and Principal Financial Officer) 11