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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-K
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(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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE COMMISSION
Commission File Number 0-23827
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PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
Delaware 02-0513618
State or other jurisdiction of (I.R.S. Employer Identification No.)
(incorporation or organization)
Rt. 101A, 730 Milford Road 03054
Merrimack, New Hampshire (Zip Code)
(Address of principal executive offices)
(603) 423-2000
Registrant's telephone number including area code
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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
20, 2002, was $79,122,304. 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
20, 2002 was 24,555,145.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2002 Annual Meeting of
Shareholders for the fiscal year ended December 31, 2001, which is to be filed
within 120 days of the end of the Company's fiscal year, are incorporated by
reference into Part III of this Form 10-K. The incorporation by reference
herein of portions of the Proxy Statement shall not be deemed to specifically
incorporate by reference the information referred to in Item 402(a) (8) of
Regulation S-K.
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PC CONNECTION, INC. AND SUBSIDIARIES
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
Page
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PART I
ITEM 1. Business............................................................................. 1
ITEM 2. Properties........................................................................... 10
ITEM 3. Legal Proceedings.................................................................... 10
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............. 12
ITEM 6. Selected Financial and Operating Data................................................ 13
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk............................ 27
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 the overall level of economic activity and
the level of business investment in information technology products. 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
We are a direct marketer of information technology products and solutions,
including brand-name personal computers and related peripherals, software,
accessories and networking products through our three sales subsidiaries, PC
Connection Sales Corporation, PC Connection Sales of Massachusetts, Inc. and
GovConnection, Inc. (formerly ComTeq Federal, Inc.). Our principal customers
are small and medium-sized businesses, known as SMBs, comprised of 20 to 1,000
employees, as well as governmental agencies and educational orgranizations. We
sell our products through a combination of targeted direct mail catalogs,
outbound telemarketing, our Internet Web site and advertisements on the
Internet and in selected computer magazines. We offer 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,
Acer, Fujitsu, Canon, Iomega and Apple. Our most frequently ordered products
are carried in inventory and are typically shipped to customers the same day
that the order is received.
Since our founding in 1982, we have served our customers' needs by providing
innovative, reliable and timely service and technical support, and by offering
an extensive assortment of branded products, through knowledgeable,
well-trained sales and support teams. Our strategy's effectiveness is reflected
in the recognition we have received, including being named to the Forbes
Platinum 400, the Fortune 1000 and Information Week's list of Top 500 leading
IT Innovators during 2001. Additionally in 2001, the Better Business Bureau of
New Hampshire awarded us the coveted Torch Award for Marketplace Ethics.
We believe that our consistent customer focus has also resulted in the
development of strong brand name recognition and a broad and loyal customer
base. At December 31, 2001, our mailing list consisted of approximately
3,404,000 customers and potential customers, of which approximately 471,000 had
purchased products from us within the last twelve months. Approximately 76% of
our net sales in the year ended December 31, 2001 were made to customers who
had previously purchased products from us. We believe we also have strong
relationships with vendors, resulting in favorable product allocations and
marketing assistance.
Enterprise network infrastructure products, such as PC-based servers,
routers and switches, accounted for 19.8% of our total net sales in 2001, up
from 17.4% of our total net sales in 2000. Over the next few years, we
anticipate that an increasing share of our revenues will come from the sale of
enterprise network infrastructure products and services, including
network-based storage solutions, versus the current sales concentration in
desktop and portable computers.
1
We focus our business-to-business marketing efforts on SMBs and government
and educational organizations. At December 31, 2001, we employed 464 account
managers, including 206 new account managers with less than 12 months of
outbound telemarketing experience with us. Account managers are responsible for
managing corporate accounts and focus on outbound sales calls to prospective
customers. We are focusing on recruiting experienced account managers and
increasing our existing account managers' success rate.
We publish several catalogs, including PC Connection(R) Professional Edition
for information technology professionals, 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, along with
toll-free telephone numbers for ordering, our catalogs are recognized as a
leading source for personal computer hardware, software and other related
products. We distributed approximately 42 million catalogs during the year
ended December 31, 2001.
We also market our products and services through our Internet Web sites,
www.pcconnection.com, www.govconnection.com and www.macconnection.com. Our 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 2001 were $25.2 million,
or 9.2% of that quarter's net sales. Online sales in the fourth quarter of 2001
decreased 17.6% over the comparable quarter in 2000. For the fiscal year 2001,
these sales were $102.9 million, or 8.7% of net sales, compared to 7.8% in 2000.
The Internet supports three key business initiatives for us:
. Customer choice -- We have built our business on the premise that our
customers should be able to choose how they interact with us, be it by mail,
telephone, fax, e-mail or over the Web.
. Lowering transactions costs -- Our Web site tools, including robust product
search features, Smart Selectors(R), Internet Business Accounts(R) and
special interest pages, allow customers to quickly and easily find
information about products of interest to them. If they still have
questions, our 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 -- Our investments in
technology-based sales and service programs demonstrate the power of
technology at its best - leveraging our Account Managers to do what they do
best: building and maintaining relationships with our customers and helping
them to solve their business problems.
ComTeq Federal, Inc. Changes Name To GovConnection, Inc.
On January 17, 2002, we announced that our wholly-owned subsidiary, ComTeq
Federal, Inc., will operate under a new name, GovConnection, Inc. Since 1993,
that Company has been a leading supplier of information technology (IT)
products and solutions for federal government agencies.
The name change underscores recent rapid growth in GovConnection's sales and
customer base, which in addition to federal agencies, will include state and
local government agencies, as well as schools and colleges. The new name also
better reflects our emphasis on customer service, as well as rapid response in
the delivery of complex IT solutions to all public sectors.
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 products and services with approximately $100
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.
2
We believe that sales of computing and information technology products
through the direct marketing channel will continue to grow faster than sales
for the overall industry due primarily to increased user familiarity with PCs,
coupled with the emergence of industry standards and component commonality, and
broader product offerings, lower prices and greater purchasing convenience that
direct marketers generally provide over traditional retail stores and local
dealers.
Users of personal computers range from large corporate entities focused on
business applications to individual consumers focused primarily on personal
productivity, education and entertainment applications. Historically, large
corporate resellers have served the needs of FORTUNE 1000 companies, and
retailers have competed to serve the consumer market. SMBs, our core target
customers, are being served by a wide range of suppliers, including direct
marketers, large retailers, and small, independent value added resellers, known
as VARs, and local dealerships. We believe 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
who have traditionally used resellers to distribute their products have
established or attempted to establish their own direct marketing operations,
including sales through the Internet, to our knowledge, only one has replaced
its traditional indirect selling channels as the principal means of
distribution. Accordingly, we believe these manufacturers will continue to
provide us and other third-party direct marketers favorable product allocations
and marketing support.
We believe 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
Our objective is to become the leading supplier of information technology
products and solutions, including personal computers and related products and
services, to our customers. The key elements of our business strategies include:
. We provide award-winning customer service before, during and after the
sale. We believe that we have earned a reputation for providing superior
customer service by consistently focusing on our customer needs. We have 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". We deliver value to our customers through high quality
service and technical support provided by our knowledgeable, well-trained
personnel. We have efficient and innovative delivery programs, and we also
offer our customers competitive prices and reasonable return policies.
. We maintain a strong brand name and customer awareness. Since our founding
in 1982, we have built a strong brand name and customer awareness. In July
1999, we were the only direct reseller included in the "100 Most Influential
Companies in the Computer Industry" by PC Magazine. In 2001, we were named
to the Forbes Platinum 400, the Fortune 1000 and Information Week's list of
top 500 Leading IT Innovators. Our mailing list includes approximately
3,404,000 names, of which approximately 471,000 have purchased products from
us during the last 12 months.
3
. We offer a broad product selection at competitive prices. We offer our
customers a wide assortment of information technology products and
solutions, including personal computers and related products, at competitive
prices. Our 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.
. We have long-standing vendor relationships. We have a history of strong
relationships with vendors, and were among the first direct marketers
qualified by manufacturers to market computer systems to end users. We
provide our vendors with both information concerning customer preferences
and an efficient channel for the advertising and distribution of their
products.
Growth Strategies
Our growth strategies are to increase our penetration of our existing
customer base, broaden our product offerings and expand our customer base. The
key elements of our growth strategies include:
. Focus on enterprise server and networking opportunities. We are
accelerating our transition from an end-user or desktop-centric computing
supplier to a network or enterprise-centric computing supplier. In 2001,
sales of enterprise server and networking products accounted for 19.8% of
our total net sales compared to 17.4% of our total net sales in 2000. Sales
of enterprise products typically have larger average order sizes and higher
gross margins than do sales of desktop computing products.
. Expand product and service offerings. We continually evaluate information
technology products and services focused on business users, adding new
products and services as they become available or in response to customer
demand. We work closely with vendors to identify and source first-to-market
product offerings at aggressive prices, and believe that the expansion of
our corporate outbound marketing program will enhance our access to such
product offerings.
. Target high growth customer segments. Through targeted mailings, we seek to
expand the number of our active customers and generate additional sales from
our existing customers. We have 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. In 2001, we focused on growing sales in our government
and education segments. Such sales totaled $286.8 million in 2001, compared
to $245.2 million in 2000, for a 17.0% increase.
. Increase outbound telemarketing. We plan to continue to increase the number
of our corporate outbound account managers and assign them to a greater
number of our customers. Outbound account managers focus exclusively on
serving specifically assigned customers and seek to develop a close
relationship with those customers by identifying and responding to their
needs for personal computers and related products.
. Expand electronic commerce channel. Our Internet Web-based catalog provides
detailed product descriptions, product search capabilities and on-line order
processing. We plan to further improve on-line sales capabilities, customer
service and product information and customer support available on our
Internet Web site. During 2001, the number of customers utilizing our
proprietary Internet Business Accounts(R) grew to approximately 29,500 at
December 31, 2001 from 15,500 at December 31, 2000.
. Pursue strategic acquisitions and alliances. Through our acquisition
program, we seek to acquire new customers, strengthen our product offerings,
add management talent and produce operating results which are accretive to
our core business earnings.
Service And Support
Since our founding in 1982, our 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
4
service and support. We believe that offering our customers superior value,
through a combination of product knowledge, consistent and reliable service and
leading products at competitive prices, differentiates us from other direct
marketers and provides the foundation for developing a broad and loyal customer
base.
We invest in training programs for our service and support personnel, with
an emphasis on putting customer needs and service first. Customer service
representatives are available 24 hours a day, seven days a week to handle
orders, product information and general inquiries, and technical support
questions.
We provide toll-free technical support from 9 a.m. through 5 p.m., eastern
time, Monday through Friday. Product support technicians assist callers with
questions concerning compatibility, installation, determination of defects and
more difficult questions relating to product use. The product support
technicians authorize customers to return defective or incompatible products to
either the manufacturer or to us for warranty service. In-house technicians
perform both warranty and non-warranty repair on most major systems and
hardware products.
Using our customized information system, we send our customer orders to our
distribution center for processing immediately after a customer receives credit
approval. Through our Everything Overnight(R) service, we guarantee that all
orders accepted up until 2:00 a.m. (until midnight on most custom-configured
systems) will be shipped for overnight delivery via Airborne Express. We also
configure approximately 20% of the computer systems we sell. Configuration
typically consists of the installation of memory, accessories and/or software.
Marketing And Sales
We sell our products through our direct marketing channel, primarily to
SMBs, governmental agencies and educational organizations. We seek to be the
primary supplier of information technology products and solutions, including
personal computers and related products, to our existing customers and to
expand our customer base. We use 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 our marketing approaches emphasize our broad product offerings, fast
delivery, customer support, competitive pricing and multiple payment options.
We believe that our ability to establish and maintain long-term customer
relationships and to encourage repeat purchases is largely dependent on the
strength of our telemarketing personnel and programs. Because our customers'
primary contact with us is through our telemarketers, we are committed to
maintaining a qualified, knowledgeable and motivated sales staff with its
principal focus on customer service.
The following table sets forth our percentage of net sales by sales channel:
Years Ended December 31,
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Sales Channel 2001 2000 1999
------------- ----- ----- ----
Outbound Telemarketing 79% 76% 65%
Inbound Telesales..... 12 16 29
On-Line Internet...... 9 8 6
----- ----- ----
Total............. 100% 100% 100%
===== ===== ====
Outbound Telemarketing. We seek to build loyal relationships with our
potential high-volume customers by assigning them to individual account
managers. We believe that customers respond favorably to a one-on-one
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relationship with personalized, well-trained account managers. Once
established, these one-on-one relationships are maintained and enhanced through
frequent telecommunications and targeted catalogs and other marketing materials
designed to meet each customer's specific computing needs.
Account managers focus exclusively on their managed accounts and on outbound
sales calls to prospective customers. We generally recruit account managers
from other sales organizations and from our inbound telemarketing staff. All
account managers must successfully complete a three-month training program,
which includes instruction in our 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 our
vendors. We pay our account managers a base annual salary plus incentive
compensation. Incentive compensation is tied to gross profit dollars produced
by the individual account manager. Account managers historically have
significantly increased productivity after approximately 12 months of training
and experience. At December 31, 2001, we employed 464 account managers,
including 206 with less than 12 months of outbound telemarketing experience
with us.
Catalogs and Inbound Telesales. Our two principal catalogs are PC
Connection(R) for the PC market and MacConnection(R) for the Mac market. We
publish twelve editions of each of these catalogs annually. We distribute
catalogs to purchasers on our in-house mailing list as well as to other
prospective customers. We send our two principal catalogs to our 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. We also include a catalog with each order shipped.
In addition, we mail specialty catalogs or customized versions of our
catalogs, including our new Information Technology Professional Edition, to
selected customers. We distribute specialty catalogs to information technology
professionals, educational and governmental customers and prospects on a
periodic basis. We also distribute our 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 our 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 our 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 cost savings to us. After completion of the design and preparation,
we outsource the catalogs to commercial printers for printing.
Our inbound sales representatives answer customer telephone calls generated
by our 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. We provide training to our inbound telemarketing personnel and
provide incentive compensation based upon sales productivity. We have a
flexible staffing model which allows us to maintain excellent customer service
during periods of peak demand while maintaining an efficient cost structure. We
regularly monitor calls for quality assurance purposes. We have been a pioneer
in using caller identification for the instant retrieval of customer records.
Using our 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 our toll-free numbers, orders are also received via fax, mail and
electronic mail.
6
Advertising. We have 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 our
service and support features. Additionally, the PC Connection(R) logo and
telephone number are included in promotions by selected manufacturers.
www.pcconnection.com, www.govconnection.com and www.macconnection.com. We
provide product descriptions and prices of all products on-line. We also
provide updated information for over 29,000 items and on screen images
available for over 18,000 items. We offer, and continuously update, selected
product offerings and other special buys. We believe that in the future our
Internet Web site will be an important sales source and communication tool for
improving customer service.
Specialty Marketing. Our 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. We also market call-answering and fulfillment services to
certain of our product vendors.
Customers. We currently maintain an extensive database of customers and
prospects aggregating approximately 3,404,000 names. During the year ended
December 31, 2001, we received orders from approximately 471,000 customers.
Approximately 76% of our net sales in the year ended December 31, 2001 were
made to customers who had previously purchased products from us.
Products And Merchandising
We continuously focus on expanding the breadth of our product offerings. We
currently offer approximately 100,000 information technology products designed
for business applications from over 1,000 manufacturers, including hardware and
peripherals, accessories, networking products and software. We offer both PCs
and Macs and related products. In 2001, sales of PCs and related products were
approximately 90% of our net sales. We select the products that we sell based
upon their technology and effectiveness, market demand, product features,
quality, price, margins and warranties. As part of our merchandising strategy,
we also offer products related to PCs, such as digital cameras.
The following table sets forth our percentage of net sales (in dollars) of
notebooks, desktops and servers, storage devices, software, networking
communications equipment, printers, video and monitors, memory, accessories and
other products during the years ended December 31, 2001, 2000 and 1999.
PERCENTAGE OF NET SALES
-----------------------
Years Ended December 31
-----------------------
2001 2000 1999
---- ---- ----
Notebooks................ 22% 25% 23%
Desktops/Servers......... 12 15 15
Storage Devices.......... 10 10 10
Software................. 13 10 12
Networking Communications 9 8 6
Printers................. 8 7 9
Video & Monitors......... 9 8 8
Memory................... 3 4 4
Accessories/Other........ 14 13 13
--- --- ---
TOTAL............... 100% 100% 100%
=== === ===
We offer a 30-day right of return generally limited to defective
merchandise. Returns of non-defective products are subject to restocking fees.
Substantially all of the products marketed by us are warranted by the
manufacturer. We generally accept returns directly from the customer and then
either credit the customer's account or ship the customer a similar product
from our inventory.
7
Purchasing And Vendor Relations
For the year ended December 31, 2001, we purchased approximately 45.2% of
our products directly from manufacturers and the balance from distributors and
aggregators. We ship the majority of our products directly to our distribution
facility in Wilmington, Ohio. During the years ended December 31, 2001 and
2000, product purchases from Ingram Micro, our largest vendor, accounted for
approximately 24.7% and 25.6%, respectively, of our total product purchases.
Purchases from Tech Data Corporation comprised 14.1% and 11.2% of our total
purchases in the years ended December 31, 2001 and 2000, respectively. No other
vendor accounted for more than 10% of our total product purchases. We believe
that alternative sources for products obtained from Ingram Micro and Tech Data
are available.
Many product suppliers reimburse us for advertisements or other cooperative
marketing programs in our 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. We also receive
reimbursements from certain vendors based upon the volume of purchases or sales
of the vendors' products by us.
Some of our vendors offer limited price protection in the form of rebates or
credits against future purchases. We may also participate in end-of-life-cycle
and other special purchases which may not be eligible for price protection.
We believe that we generally have excellent relationships with vendors. We
generally pay vendors within stated terms and take advantage of all appropriate
discounts. We believe that because of our volume purchases we are 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 our business, we believe that competitive sources of
supply are available in substantially all of the merchandise categories offered
by us.
Distribution
At our approximately 205,000 square foot distribution and fulfillment
complex in Wilmington, Ohio, we receive and ship inventory, configure computer
systems and process returned products. Orders are transmitted electronically
from our New Hampshire, Massachusetts and Maryland sales facilities to our
Wilmington distribution center after credit approval, where packing
documentation is printed automatically and order fulfillment takes place.
Through our Everything Overnight(R) service, we guarantee that all orders
accepted up until 2:00 a.m. (until midnight on custom-configured systems) will
be shipped for overnight delivery via Airborne Express. We ship approximately
56% of our orders through Airborne Express. Upon request, orders may also be
shipped by other common carriers.
We also place product orders directly with manufacturers and/or distribution
companies for drop shipment by those manufacturers and/or suppliers directly to
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. Products drop
shipped by suppliers accounted for 22.0% of net sales in 2001 and 11.4% of net
sales in 2000. In future years, we expect that products drop shipped from
suppliers will increase, both in dollars and as a percentage of net sales, as
we seek to lower our overall inventory and distribution costs while maintaining
excellent customer service.
Management Information Systems
We use management information systems, principally comprised of applications
software running on IBM AS/400 and RS6000 computers and Microsoft NT-based
servers, which we have customized for our 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.
We also operate advanced telecommunications equipment to
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support our sales and customer service operations. Key elements of the
telecommunications systems are integrated with our computer systems to provide
timely customer information to sales and service representatives, and to
facilitate the preparation of operating and performance data. We believe that
our customized information systems enable us to improve our productivity, ship
customer orders on a same-day basis, respond quickly to changes in our industry
and provide high levels of customer service.
Our success is dependent in large part on the accuracy and proper use of our
information systems, including our telephone systems, to manage our inventory
and accounts receivable collections, to purchase, sell and ship our products
efficiently and on a timely basis, and to maintain cost-efficient operations.
We expect to continually upgrade our information systems to more effectively
manage our operations and customer database.
Competition
The direct marketing and sale of information technology products, including
personal computers and related products, is highly competitive. PC Connection
competes with other direct marketers of information technology products,
including CDW Computer Centers, Inc. and Insight Enterprises, Inc. We also
compete 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;
. various cost-plus aggregators, franchisers, and national computer
retailers, such as CompUSA, Inc.; and
. companies with more extensive Internet Web sites and commercial on-line
networks.
Additional competition may arise if other new methods of distribution, such
as broadband electronic software distribution, emerge in the future.
We compete not only for customers, but also for favorable product
allocations and cooperative advertising support from product manufacturers.
Several of our competitors are larger and have substantially greater financial
resources than us.
We believe that price, product selection and availability, and service and
support are the most important competitive factors in our industry.
Intellectual Property Rights
Our trademarks include PC Connection(R), GovConnection(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), and Memory Connection(TM), Your Brands, Your Way, Next Day(R),
Epiq PC Systems(R) and Webase(R). We intend to use and protect these and our
other marks, as we deem necessary. We believe our trademarks and service marks
have significant value and are an important factor in the marketing of our
products. We do not maintain a traditional research and development group, but
we work closely with computer product manufacturers and other technology
developers to stay abreast of the latest developments in computer technology,
both with respect to the products we sell and use.
Employees
As of December 31, 2001, we employed 1,312 persons, of whom 618 were engaged
in sales related activities, 90 were engaged in providing customer service and
support, 345 were engaged in purchasing, marketing and distribution related
activities, 86 were engaged in the operation and development of management
information systems, and 173 were engaged in administrative and accounting
functions. We consider our employee relations to be good. Our employees are not
represented by a labor union, and we have never experienced a work stoppage
since our inception.
9
Item 2. Properties
In November 1997, we entered into a fifteen year lease for our corporate
headquarters and telemarketing center located at Route 101A, 730 Milford Road,
Merrimack, New Hampshire 03054-4631, with an affiliated entity, G&H Post, which
is related to PC Connection through common ownership. The total lease is valued
at approximately $7.0 million, based upon an independent property appraisal
obtained at the date of lease, and interest is calculated at an annual rate of
11%. The lease requires us to pay our proportionate share of real estate taxes
and common area maintenance charges as additional rent and also to pay
insurance premiums for the leased property. We have the option to renew the
lease for two additional terms of five years each. The lease has been recorded
as a capital lease in the financial statements.
We also lease 205,000 square feet in two facilities in Wilmington, Ohio,
which houses our distribution and order fulfillment operations. The Ohio leases
will expire in 2002 and 2003. We are currently in the process of renegotiating
the Ohio lease set to expire in 2002. We also operate telemarketing centers in
Dover, Amherst and Keene, New Hampshire, as well as Marlborough, Massachusetts
and Rockville, Maryland. We believe that existing distribution facilities in
Wilmington, Ohio will be sufficient to support our anticipated needs through
the next twelve months.
Item 3. Legal Proceedings
On February 12, 2002, Microsoft Corporation filed a complaint against PC
Connection in New Hampshire Federal District Court alleging that we had sold
counterfeit shrinkwrapped, packaged software and, in the process, infringed on
Microsoft's trademarks and copyrights. While we never counterfeited Microsoft
products, nor knowingly resold counterfeit Microsoft products, we believed that
it was in our best interest to settle the dispute rather than to litigate.
While denying the allegations, we agreed to pay Microsoft $625,000 to settle
the case. The settlement costs and related legal fees of approximately $125,000
will be included as a special charge in our first quarter 2002 financial
results.
We also agreed in the settlement to acquire Microsoft products only through
distributors identified as authorized by Microsoft, codifying a policy that we
have had in place since early 2001.
On March 20, 2002, The Lemelson Medical, Education & Research Foundation,
L.P. filed a complaint in federal district court in the State of Arizona naming
us as an additional defendant in the so-called "Federal Express" case. The
Federal Express case involves approximately eighty-eight defendants and
pertains to claims made by the foundation relating to its right to royalties
for the use of bar code scanners that allegedly utilize technology covered by
patents now owned by the foundation. The foundation has previously filed claims
against manufacturers of bar code scanners and has now also filed claims
against users of bar code scanners, including PC Connection. The manufacturers
of bar code scanners and the foundation are currently engaged in litigation in
Nevada Federal District Court relating to the validity of the patents at issue.
The defendants in the Arizona litigation have requested the federal district
court to stay the proceedings pending the outcome of the Nevada litigation,
which the Court granted. Until the Nevada patent litigation is resolved, we
will expend little, if any, legal fees in the Arizona case. If the bar code
manufacturers are successful in the Nevada case, we expect the Arizona court to
dismiss the action against us.
The foundation has not specified the amount of damages it seeks in its
complaint, but such damages may be material. If the foundation ultimately
prevails in the Arizona litigation, the damages assessed against us may be
material and may have a material adverse effect on our financial condition. In
addition, we may be required to modify the methods by which we track
inventories and ship products which may have a material adverse effect on our
results of operations. We intend to vigorously defend this claim and, to the
extent we are found liable, we believe we have indemnification claims against
certain manufacturers of bar code scanners.
While we may ultimately decide to seek indemnity from certain manufacturers
of bar code scanners, we can provide no assurance that we would be successful
in obtaining such indemnity. At a minimum, if the Nevada or Arizona litigation
proceeds, we may incur material legal fees in the defense of the foundation's
claims or in seeking indemnity from certain manufacturers of bar code scanners.
10
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted during the fourth quarter of 2001 to a vote
of security holders.
Executive Officers of PC Connection
The executive officers of PC Connection and their ages as of March 20, 2002
are as follows:
Name Age Position
---- --- --------
Patricia Gallup.... 47 Chairman
Kenneth Koppel..... 58 Chief Executive Officer
Wayne L. Wilson.... 53 President and Chief Operating Officer
Robert F. Wilkins.. 40 Executive Vice President
Mark A. Gavin...... 40 Senior Vice President of Finance and Chief Financial
Officer
Bradley G. Mousseau 50 Vice President of Human Resources
Patricia Gallup is a co-founder of the Company and has served as Chairman
since June 2001. From January 1998 to June 2001, Ms. Gallup served as Chairman
and Chief Executive Officer of the Company. From September 1995 to January
1998, Ms. Gallup served as the Chairman, President and Chief Executive Officer
of the Company. From September 1994 to September 1995, she served as Chairman
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.
Kenneth Koppel has served as Chief Executive Officer of the Company since
June 2001. Prior to joining the Company, Mr. Koppel served as a principal in or
a consultant to several new media and marketing companies, including an
assignment as an interim executive at PC Connection. From 1972 to 1992, Mr.
Koppel served in a variety of roles at Ziff-Davis Publishing Company, including
President of Ziff-Davis Publishing and President of Ziff Communications.
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 from April 1989 to March 1998. Prior to CFX, Mr. Gavin worked as a
Manager for Ernst & Young, LLP.
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.
11
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
Market Information
PC Connection's Common Stock commenced trading on March 3, 1998 on the
Nasdaq National Market under the symbol "PCCC". As of March 20, 2002, there
were 24,555,145 shares outstanding of the Common Stock of PC Connection held by
approximately 90 stockholders of record.
The following table sets forth for the fiscal periods indicated the range of
high and low bid prices for our Common Stock on the Nasdaq National Market.
These prices reflect the three-for-two stock split distributed on May 23, 2000.
2001 High Low
---- ------ ------
Quarter Ended:
December 31.. $17.79 $ 6.85
September 30. 16.30 6.00
June 30...... 16.77 8.50
March 31..... 20.56 8.13
2000
----
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
We have never declared or paid cash dividends on our capital stock. We
currently anticipate that we will retain all future earnings, if any, to fund
the development and growth of our business, and we do not anticipate paying any
cash dividends on our Common Stock in the foreseeable future.
12
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, 2001 are
derived from the audited financial statements of the Company. The Company's
consolidated financial statements as of December 31, 2001 and 2000 and for each
of the years in the three-year period ended December 31, 2001 and the
independent auditors' report thereon, are included elsewhere herein.
Years Ended December 31,
-------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
(dollars in thousands, except per share and selected operating data
Statement of Operations Data:
Net sales......................................... $ 1,180,951 $ 1,449,908 $ 1,080,835 $ 749,905 $ 562,511
Cost of sales..................................... 1,049,799 1,273,687 951,489 656,631 486,545
----------- ----------- ----------- ----------- -----------
Gross profit...................................... 131,152 176,221 129,346 93,274 75,966
Selling, general and administrative expenses...... 117,508 123,972 91,405 68,521 56,596
Additional stockholder/officer compensation/(1)/.. -- -- -- 2,354 12,130
Restructuring costs and other special charges/(2)/ 2,204 -- -- -- --
----------- ----------- ----------- ----------- -----------
Income from operations............................ 11,440 52,249 37,941 22,399 7,240
Interest expense.................................. (1,179) (2,086) (1,392) (415) (1,355)
Other, net........................................ 1,307 589 116 565 (42)
----------- ----------- ----------- ----------- -----------
Income before income taxes........................ 11,568 50,752 36,665 22,549 5,843
Income tax provision/(3)/......................... (4,396) (19,289) (13,935) (3,905) (639)
----------- ----------- ----------- ----------- -----------
Net income........................................ $ 7,172 $ 31,463 $ 22,730 $ 18,644 $ 5,204
=========== =========== =========== =========== ===========
Pro Forma Data/(4)/
-------------------------
Basic net income per share/(5)/................... $ .29 $ 1.31 $ .97 $ .61 $ .17
=========== =========== =========== =========== ===========
Diluted net income per share/(5)/................. $ .29 $ 1.23 $ .94 $ .59 $ .17
=========== =========== =========== =========== ===========
Selected Operating Data:
Active customers/(6)/............................. 471,000 626,000 732,000 684,000 510,000
Catalogs distributed.............................. 41,683,000 45,028,000 47,325,000 42,150,000 33,800,000
Orders entered/(7)/............................... 1,265,000 1,521,000 1,622,000 1,510,000 1,252,000
Average order size/(7)/........................... $ 1,116 $ 1,115 $ 781 $ 580 $ 524
December 31,
-------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
(dollars in thousands)
Balance Sheet Data:
Working capital................................... $ 120,856 $ 111,669 $ 72,250 $ 53,768 $ 18,907
Total assets...................................... 244,235 250,413 223,537 164,510 105,442
Short-term debt................................... 1,171 1,153 1,137 123 29,568
Long-term debt (less current maturities):
Capital lease obligations....................... 6,621 6,792 6,945 7,081 --
Term loan....................................... -- -- -- -- 3,250
Note payable.................................... -- 1,000 2,000 -- --
Total stockholders' equity........................ 147,176 138,687 94,223 69,676 24,120
- --------
/(1)/ 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.
13
/(2)/ Includes $1,510 for the cost of reductions in the Company workforce and
$694 for costs relating to a proposed acquisition that was abandoned
during the year.
/(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.
/(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.
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
Company's industry, 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 the overall level of economic activity and the level of business investment
in information technology products. 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.
Significant Accounting Policies
The consolidated financial statements of PC Connection are prepared in
conformity with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires us to make
certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available. These estimates and assumptions affect
the reported amounts of assets, liabilities, revenues and expenses during the
periods presented. The significant accounting policies which we believe are the
most critical to aid in fully understanding and evaluating our reported
financial results include the following:
Revenue Recognition
Revenue on products 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. We generally obtain oral and written purchase authorizations from our
customers for a specified amount of product at a specified price and consider
delivery to have occurred at the point of shipment, except
for sales to federal agencies, for which delivery occurs at destination. We
provide our customers with a limited thirty day right of return only for
defective merchandise. Revenue is recognized at shipment and a reserve for
14
sales returns is recorded. The Company has demonstrated the ability to make
reasonable and reliable estimates of product returns in accordance with
Statement of Financial Accounting Standards No. 48 ("SFAS No. 48"), "Revenue
Recognition When Right of Return Exists", based on significant historical
experience. Should such returns no longer prove to be estimable, we believe
that the impact on our financials would not necessarily be significant since
the return privilege expires 30 days after shipment.
Accounts Receivable
We perform ongoing credit evaluations of our customers and adjust credit
limits based upon payment history and customers' current credit worthiness.
Collections are monitored continuously, and an allowance for estimated doubtful
accounts is maintained based on our historical experience and customer
collection issues identified. While such credit losses have historically been
within our expectations, further deterioration of customers' ability to make
required payments may make additional allowances necessary.
In addition to accounts receivable from customers, we record receivables
from vendors/suppliers for cooperative advertising, price protection, supplier
reimbursements, rebates and other similar arrangements. A portion of such
receivables is estimated based on information available from our vendors at
discrete points in time. While such estimates have historically approximated
actual cash received, an unanticipated change in a promotional program could
give rise to a reduction in the receivable.
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. Inventory quantities
on hand are reviewed regularly, and provisions are made for obsolete, slow
moving and nonsalable inventory, based primarily on management's forecast of
customer demand for those products in inventory. The PC industry is
characterized by rapid technological change and new product development that
could result in increased obsolescence of inventory on hand. Increased
obsolescence or decreased customer demand beyond management's expectations
could require additional provisions.
Recent Developments
On March 25, 2002, we entered into an Agreement and Plan of Merger with
MoreDirect, Inc., a Florida corporation. MoreDirect is an e-procurement
supplier of information technology products for medium-to-large corporate and
government organizations nationwide. Pursuant to the merger agreement,
MoreDirect will be merged with our newly formed Florida merger subsidiary.
Following the merger, MoreDirect will continue its operations as our wholly
owned subsidiary under its existing management. Under the terms of the merger
agreement, MoreDirect's stockholders will receive approximately $21,000,000 at
closing. The merger agreement contemplates an earn-out period of three years
following the closing whereby if MoreDirect maintains certain earnings before
income tax, or EBIT, levels, additional payments will be made to MoreDirect's
stockholders. Under the merger agreement, earn-out payments are tied to EBIT
levels targeted to grow at a 15% rate per year. The maximum payments we will
make under the earn-out provisions of the merger agreement are $67,106,000,
assuming MoreDirect maintains 200% of targeted EBIT levels for all three years.
If MoreDirect maintains less than 60% of targeted EBIT levels for all three
years, no payments would be required under the earn-out provisions of the
merger agreement. At any time during the earn-out period, we may "buy-out" the
remaining earn-out payments for amounts which vary during the term of the
earn-out. We will also escrow $10,000,000 at closing to fund a portion of these
contingent payments. Certain portions of the contingent payments may be
converted into our common stock at specified conversion prices between $20.80
and $40.00 per share. The consummation of the transactions contemplated in the
merger agreement are subject to the satisfaction of several conditions. Our
acquisition of MoreDirect will be immediately accretive to earnings and will be
accounted for under the purchase method of accounting.
15
General
PC Connection 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. We initially sought
customers through advertising in selected computer industry publications and
the use of inbound toll-free telemarketing. Currently, we generate sales
through (i) outbound telemarketing by account managers focused on the business,
education and government markets, (ii) inbound calls from customers responding
to our catalogs and other advertising and (iii) our Internet Web site.
We offer both PC compatible products and Mac compatible products. Reliance
on Mac product sales has decreased over the last three years, from 19.4% of net
sales for the year ended December 31, 1998 to 10.1% of net sales for the year
ended December 31, 2001. We believe 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 2002 and future years.
The weakness in demand for information technology products experienced by us
in the fourth quarter of 2000 continued through 2001, resulting in overall
conservative buying patterns, order deferrals and longer sales cycles.
Sales of computer systems result in a relatively high dollar sales order, as
reflected in the increase in our average order size from $580 in the year ended
December 31, 1998 to $1,116 in the year ended December 31, 2001. Computer
systems generally provide the largest gross profit dollar contribution per
order of all our products, although they usually yield the lowest gross margin
percentage.
Our 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 we
intend 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. We believe that outbound
sales will continue to represent a larger portion of our business mix in future
periods.
The direct marketing of personal computers and related products is highly
competitive. In addition to other direct marketers and manufacturers who sell
direct, such as Dell and Gateway, manufacturers of PCs sold by us, such as
Apple, Compaq and IBM, have also implemented varying plans to sell PCs directly
to end users. We currently believe that direct sales by Compaq and IBM will not
have a significant adverse effect upon our net sales.
Most product manufacturers provide us with co-op advertising support in
exchange for product coverage in our catalogs. Although the level of co-op
advertising support available to us from certain manufacturers has declined,
and may decline further in the future, the overall level of co-op advertising
programs has remained consistent with our levels of spending for catalog and
other advertising programs. We believe that the overall levels of co-op
advertising programs available over the next twelve months will be consistent
with our planned advertising programs. For financial reporting purposes,
revenue garnered from cooperative advertising services is offset against
selling, general and administrative expenses in our consolidated statements of
income.
16
Results of Operations
The following table sets forth for the periods indicated information derived
from our statements of income expressed as a percentage of net sales.
Years Ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
Net sales (in millions)...................... $1,181.0 $1,449.9 $1,080.8
======== ======== ========
Net sales.................................... 100.0% 100.0% 100.0%
Gross profit................................. 11.1 12.2 12.0
Selling, general and administrative expenses. 9.9 8.6 8.5
Restructuring costs and other special charges 0.2 0.0 0.0
Income from operations....................... 1.0 3.6 3.5
The following table sets forth our percentage of net sales by platform,
sales channel, and product mix:
Years Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Platform
PC and Multi Platform.... 90% 90% 85%
Mac...................... 10 10 15
--- --- ---
Total.................. 100% 100% 100%
=== === ===
Sales Channel
Corporate Outbound....... 79% 76% 65%
Inbound Telesales........ 12 16 29
On-Line Internet......... 9 8 6
--- --- ---
Total.................. 100% 100% 100%
=== === ===
Product Mix
Notebooks................ 22% 25% 23%
Desktop/Servers.......... 12 15 15
Storage Devices.......... 10 10 10
Software................. 13 10 12
Networking Communications 9 8 6
Printers................. 8 7 9
Video & Monitors......... 9 8 8
Memory................... 3 4 4
Accessories/Other........ 14 13 13
--- --- ---
Total.................. 100% 100% 100%
=== === ===
Sales of enterprise server and networking products (included in the above
product mix) were 19.8%, 17.4% and 11.6% of net sales for the years ended
December 2001, 2000 and 1999, respectively.
17
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net sales decreased $268.9 million, or 18.5%, to $1,181.0 million in 2001
from $1,449.9 million in 2000. The decrease in net sales was due to the
weakness in demand for information technology products. Outbound sales
decreased $162.1 million, or 14.7%, to $937.8 million from $1,099.9 million in
2000. While there was an overall decrease in outbound sales, this channel
increased as an overall component of our business. Outbound sales increased by
3% as a percentage of overall net sales to 79% in 2001 as compared to 76% in
2000. Inbound sales, which primarily serve our consumer and very small business
customers decreased $96.8 million, or 40.8%, to $140.2 million, from $237.0
million in 2000. Online Internet sales decreased $10.1 million, or 8.9%, to
$102.9 million from $113.0 million in 2000, however online Internet sales
increased to 9% of total net sales in 2001, as compared to 8% of total net
sales in 2000. Our sales to consumers and small businesses were more negatively
impacted during the 2001 economic slowdown than were sales to our larger
business customers, who generally purchase through either the outbound or
Internet channels. We believe that sales to consumers and small businesses will
continue to be more heavily impacted than sales to large business customers if
the economic slowdown continues.
Net sales of enterprise server and networking products decreased 7.5% to
$234.0 million in 2001 as compared to $253.0 million in 2000. Enterprise server
and networking products represented 19.8% of overall net sales for the year, up
from 17.4% for the year ended 2000. While sales of these products declined in
absolute dollar amounts in 2001, we believe that sales of these product
categories will continue to grow as a percentage of our net sales as customers
further upgrade their network and communication infrastructures. If economic
conditions do not improve in the near term, the anticipated sales growth of
these types of products will not likely occur as expected.
As of December 31, 2001, the number of outbound sales account managers
totaled 464, a 19.3% decrease, compared to 575 account managers at the end of
2000. We are focusing on recruiting experienced account managers and increasing
the success rate of our existing account managers.
Gross profit decreased $45.0 million, or 25.5%, to $131.2 million in 2001
from $176.2 million in 2000. The decrease in gross profit dollars was
attributable to the decrease in net sales described above. Gross profit margin
decreased from 12.2% in 2000 to 11.1% in 2001 due to a more competitive pricing
environment, and other market conditions. Our profit margins are also
influenced by the relative mix of inbound, outbound and on-line Internet sales.
Our gross margin may vary based upon vendor support programs, product mix,
pricing strategies, market conditions and other factors.
Selling, general and administrative expenses decreased $6.5 million, or
5.2%, to $117.5 million in 2001 from $124.0 million in 2000 and increased as a
percentage of sales to 9.9% in 2001 from 8.6% in 2000. We expect that our
selling, general and administrative expenses ("SG&A") may vary depending on
changes in sales volume, as well as the levels of continued investments in key
growth initiatives such as hiring more experienced outbound sales account
managers, improving marketing programs, and deploying next generation Internet
Web technology to support the sales organization.
Restructuring costs and other special charges totaling $2.2 million, were
recorded in the year 2001. These costs related to staff reductions of $1.5
million, and $0.7 million of costs associated with proposed acquisitions
abandoned during the year.
18
A rollforward of restructuring costs and other special charges for the
twelve months ended December 31, 2001 is shown below. There were no changes in
estimates in the interim periods.
Total Cash Liabilities at
Charges Payments December 31, 2001
------- -------- -----------------
(in thousands)
Workforce Reduction........................ $1,510 $(1,085) $ 425
Cost Associated with Abandoned Acquisitions 694 (694) 0
------ ------- -----
$2,204 $(1,779) $ 425
====== ======= =====
Income from operations decreased by $40.8 million, or 78.2%, to $11.4
million for the year ended December 31, 2001 from $52.2 million for the
comparable period in 2000. Income from operations as a percentage of net sales
decreased from 3.6% in 2000 to 1.0% in 2001 for the reasons net sales decreased
as discussed above.
Interest expense decreased by $.9 million, or 42.9%, to $1.2 million in 2001
from $2.1 million in 2000. This decrease in interest expense was attributed to
lower average borrowings outstanding in 2001 as compared to 2000 and to lower
interest rates.
Our effective tax rate was 38% for both 2001 and 2000.
Net income decreased by $24.3 million, or 77.1%, to $7.2 million in 2001
from $31.5 million in 2000, principally as a result of the decrease in income
from operations.
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.
Our 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 net sales increased
as 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 our line of credit
necessitated by our growth. Interest expense is offset by interest income from
short-term investments.
Our 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.
19
Liquidity and Capital Resources
We have historically financed our operations and capital expenditures
through cash flow from operations and bank borrowings. We believe that funds
generated from operations, together with available credit under our bank line
of credit, will be sufficient to finance our working capital and capital
expenditure requirements at least for the next twelve calendar months. Our
ability to continue funding our planned growth, both internally and externally,
is dependent upon our 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. If demand for information technology
products continues to decline, our cash flows from operations may be
substantially affected. See also those risks listed below under "Factors That
May Affect Future Results and Financial Condition".
At December 31, 2001, we had cash and cash equivalents of $35.6 million and
working capital of $120.9 million.
Net cash provided by operating activities was $34.2 million in the year
ended December 2001, compared to $4.0 million used for operating activities and
$16.0 million provided by operating activities for the years ended December 31,
2000, and 1999, respectively. The primary factors historically affecting cash
flows from operations are net income and changes in the levels of accounts
receivable, inventories and accounts payable. Since accounts receivable and
inventories have substantially decreased since December 31, 2000, cash provided
by operating activities has increased commensurately.
At December 31, 2001, we had $75.4 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 $6.4 million payable to two financial
institutions under security agreements to facilitate the purchase of inventory.
We believe we will be able to meet our obligations under our accounts payable
with cash flows from operations and our existing line of credit.
Capital expenditures were $6.1 million, $12.6 million and $7.7 million in
the years ended December 31, 2001, 2000 and 1999, respectively. We expect
capital expenditures, primarily for the purchase of computer hardware and
software and other fixed assets, to be approximately $6.8 million for the year
ending December 31, 2002.
We have 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 (4.75% at December 31, 2001) to prime 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 restrictions on the payment of
dividends, none of which we believe significantly restricts our operations. The
credit agreement matures on May 31, 2002 and we are currently renegotiating the
credit agreement. We cannot provide assurances that we will be able to
renegotiate the credit agreement on the same favorable terms as in the current
credit agreement. No borrowings were outstanding at December 31, 2001.
Under the terms of the merger agreement we entered into with MoreDirect, we
will pay MoreDirect's stockholders approximately $21,000,000 at closing. The
merger agreement contemplates an earn-out period of three years following the
closing whereby if MoreDirect maintains certain earnings before income tax, or
EBIT, levels, additional payments will be made to MoreDirect's stockholders.
Under the merger agreement, earn-out payments are tied to EBIT levels targeted
to grow at a 15% rate per year. The maximum payments we will make under the
earn-out provisions of the merger agreement are $67,106,000, assuming
MoreDirect maintains 200% of targeted EBIT levels for all three years. If
MoreDirect maintains less than 60% of targeted EBIT levels for all three years,
no payment would be required under the earn-out provisions of the merger
agreement. At any time during the earn-out period, we may "buy-out" the
remaining earn-out payments for amounts which vary during the term of the
earn-out. We will also escrow $10,000,000 at closing to fund a portion of these
contingent payments. We believe we will be able to meet our obligations to
MoreDirect and its stockholders under the merger agreement.
20
Contractual Obligations
The following summarizes our contractual obligations at December 31, 2001
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods.
Less
Than 1 - 3 After 3
December 31, 2001 Total 1 Year Years Years
------------------------------------------ ------- ------ ------ -------
(in thousands)
Contractual Obligations:
Long-term debt............................ $ 1,000 $1,000 $ - $ -
Capital lease obligation to affiliate..... 6,792 171 906 5,715
Non-cancelable operating lease obligations 11,710 5,584 5,759 367
------- ------ ------ ------
Total Contractual Obligations.......... $19,502 $6,755 $6,665 $6,082
======= ====== ====== ======
Related Parties
In November 1997, we entered into a fifteen-year lease for our corporate
headquarters with an affiliated company, G&H Post, which is related to PC
Connection through common ownership. The total lease is valued at approximately
$7.0 million, based upon an independent property appraisal obtained at the date
of lease, and interest is calculated at an annual rate of 11%. The lease
requires us to pay our proportionate share of real estate taxes and common area
maintenance charges as additional rent and also to pay insurance premiums for
the leased property. We have the option to renew the lease for two additional
terms of five years each. The lease has been recorded as a capital lease in the
financial statements.
We have other transactions with affiliate companies including G&H, G&H Post,
En Technology, and PCTV, all related to PC Connection through common ownership.
Such transactions are determined using the fair market values of such services
or products.
Year Ended
December 31,
--------------
2001 2000 1999
---- ---- ----
(in thousands)
Revenue:
Sales of various products...................... $ 3 $ 3 $425
Sales of services to affiliated companies...... 148 300 332
Costs:
Purchase of services from affiliated companies. l 9 6
Recently Issued Financial Accounting Standards
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations". SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. We do not believe that the adoption of SFAS 141
will have a significant impact on our financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which will be
effective for PC Connection on January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of the amortization of goodwill and certain other
identified intangibles. In addition, the statement includes provisions for the
reassessment of the value and useful lives of existing recognized intangibles
(including goodwill), reclassification of certain intangibles both in and out
of previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill and other
intangibles. We believe that the impact of the adoption of SFAS 142 will not be
material to the balance sheet. The Company had recorded $738 thousand in
amortization relative to goodwill in 2001. This amortization will cease in 2002.
21
Inflation
We have historically offset any inflation in operating costs by a
combination of increased productivity and price increases, where appropriate.
We do not expect inflation to have a significant impact on our business in the
future.
Factors That May Affect Future Results and Financial Condition
Our future results and financial condition are dependent on our ability to
continue to successfully market, sell and distribute information technology
products and services, including computers, hardware and software. Inherent in
this process are a number of factors that we must successfully manage in order
to achieve a favorable financial condition and favorable operating results.
Potential risks and uncertainties that could affect our future financial
condition and operating results include, without limitation, the following
factors:
There has been a recent decrease in demand throughout the industry for the
products we sell.
With the events of September 11, together with the general decline in the
economy over the past year, the demand for personal computer products has
decreased throughout the industry. This decrease adversely affected our sales
and results of operation in 2001. If our net sales do not increase in
proportion to our operating expenses or if we experience a decrease in net
sales for an extended period of time, there would be a material adverse effect
on our results of operations in future periods.
We have experienced rapid growth in recent years followed by a decline in sales
in 2001 and there is no assurance that we will be able to regain such growth.
Our net sales grew from $749.9 million for the year ended December 31, 1998
to $1.44 billion for the year ended December 31, 2000. In the year ended
December 31, 2001, our net sales declined to $1.18 billion. Our growth in
previous years placed increasing demands on our administrative, operational,
financial and other resources. Our staffing levels and operating expenses
increased substantially in recent years due to our sales forecasts. If our
revenues continue to decline, we may not be able to reduce our staffing levels
and operating expenses in a timely manner to meet our needs. Moreover, we can
provide no assurance that we will be able to regain rapid growth in the near
future.
We may also experience quarterly fluctuations and seasonality which could
impact our business.
Several factors have caused our sales and results of operations to fluctuate
and we expect 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 customer demand for hardware and software products;
. industry shipments of new products or upgrades;
. the timing of new merchandise and catalog offerings;
. fluctuations in 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;
. changes in our product offerings; and
. changes in consumer demand for information technology products.
We base our operating expenditures on sales forecasts. If revenues do not
meet expectations in any given quarter, our operating results could suffer.
22
In addition, customer response rates for our catalogs and other marketing
vehicles 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.
We are 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. Our success depends in large part on our 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, we
have and may continue to carry increased inventory levels of certain products.
By so doing, we are subject to the increased risk of inventory obsolescence.
Also, in order to implement our business strategy, we intend to continue, among
other things, to place larger than typical inventory stocking orders, and
increase our participation in first-to-market purchase opportunities. We 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, we sometimes acquire special purchase products
without return privileges. There can be no assurance that we 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 us which could negatively impact our business.
We acquire products for resale from a limited number of vendors; the loss of
any one of these vendors could have a material adverse effect on our business.
We acquire products for resale both directly from manufacturers and
indirectly through distributors and other sources. The five vendors supplying
the greatest amount of goods to us constituted 57.7% and 54.4% of our total
product purchases in the years ended December 31, 2001 and 2000, respectively.
Among these five vendors, purchases from Ingram Micro, Inc. represented 24.7%
and 25.6% of our total product purchases and purchases from Tech Data
Corporation comprised 14.1% and 11.2% of our total product purchases in the
years ended December 31, 2001 and 2000, respectively. No other vendor supplied
more than 10% of our total product purchases in the year ended December 31,
2001. If we were unable to acquire products from Ingram Micro or Tech Data, we
could experience a short-term disruption in the availability of products and
such disruption could have a material adverse effect on our results of
operations and cash flows.
Substantially all of our contracts and arrangements with our vendors that
supply significant quantities of products are terminable by such vendors or us
without notice or upon short notice. Most of our product vendors provide us
with trade credit, of which the net amount outstanding at December 31, 2001 was
$75.4 million. Termination, interruption or contraction of relationships with
our vendors, including a reduction in the level of trade credit provided to us,
could have a material adverse effect on our financial position.
Some product manufacturers either do not permit us to sell the full line of
their products or limit the number of product units available to direct
marketers such as us. An element of our business strategy is to continue to
increase our 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. We could experience a material
adverse effect to our business if we are unable to source first-to-market
purchase or similar opportunities, or if we face the reemergence of significant
availability constraints.
We may experience a reduction in the incentive programs offered to us by our
vendors.
Some product manufacturers and distributors provide us 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
. reduced advertising allowances and incentives, in some cases.
23
Most product manufacturers provide us with co-op advertising support and in
exchange we cover their products in our catalogs. This support significantly
defrays our catalog production expense. In the past, we have experienced a
decrease in the level of co-op advertising support available to us from certain
manufacturers. The level of co-op advertising support we receive from some
manufacturers may further decline in the future. Such a decline could increase
our selling, general and administrative expenses as a percentage of sales and
have a material adverse effect on our cash flows.
We face many competitive risks.
The direct marketing industry and the computer products retail business, in
particular, are highly competitive. We compete with consumer electronics and
computer retail stores, including superstores. We also compete with other
direct marketers of hardware and software and computer related products,
including an increasing number of Internet retailers. Certain hardware and
software vendors are selling their products directly through their own catalogs
and over the Internet. We compete not only for customers, but also for co-op
advertising support from personal computer product manufacturers. Some of our
competitors have greater financial, marketing and larger catalog circulations
and customer bases and other resources than we do. In addition, many of our
competitors offer a wider range of products and services than we do 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 us. We expect competition to increase as
retailers and direct marketers who have not traditionally sold computers and
related products enter the industry.
We cannot assure you that we can continue to compete effectively against our
current or future competitors. In addition, price is an important competitive
factor in the personal computer hardware and software market and we cannot
assure you that we will not face increased price competition. If we encounter
new competition or fail to compete effectively against our competitors, our
business may be harmed.
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.
We face and will continue to face significant price competition.
Generally, pricing is very aggressive in the personal computer industry and
we expect pricing pressures to continue. An increase in price competition could
result in a reduction of our profit margins. There can be no assurance that we
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, our
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 our market share, reduced sales and
reduced operating margins, any of which could have a material adverse effect on
our business.
The methods of distributing personal computers and related products are
changing and such changes may negatively impact us and our business.
The manner in which personal 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 our 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
24
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 our results of operations.
We could experience system failures which would interfere with our ability to
process orders.
We depend on the accuracy and proper use of our management information
systems including our telephone system. Many of our key functions depend on the
quality and effective utilization of the information generated by our
management information systems, including:
. our ability to manage inventory and accounts receivable collection;
. our ability to purchase, sell and ship products efficiently and on a timely
basis; and
. our ability to maintain operations.
Interruptions could result from natural disasters as well as power loss,
telecommunications failure and similar events.
Our management information systems require continual upgrades to most
effectively manage our operations and customer database. Although we maintain
some redundant systems, with full data backup, a substantial interruption in
management information systems or in telephone communication systems would
substantially hinder our ability to process customer orders and thus could have
a material adverse effect on our business.
We rely on the continued development of electronic commerce and Internet
infrastructure development.
We have had an increasing amount of sales made over the Internet in part
because of the growing use and acceptance of the Internet by end-users. No one
can be certain that 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 our Internet sales is
dependent on potential customers using the Internet in addition to traditional
means of commerce to purchase products. We cannot accurately predict the rate
at which they will do so.
Our success in growing our 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. Our ability to increase the speed with which we provide
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 and these networks may not continue to be developed.
We depend heavily on third party shippers to deliver our products to customers.
We ship approximately 56% of our 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 our ability to market or deliver products to customers on a
timely basis.
We may experience potential increases in shipping, paper and postage costs,
which may adversely affect our business if we are not able to pass such
increases on to our customers.
Shipping costs are a significant expense in the operation of our business.
Increases in postal or shipping rates and paper costs could significantly
impact the cost of producing and mailing our catalogs and shipping customer
orders. Postage prices and shipping rates increase periodically and we have no
control over future increases. We have a long-term contract with Airborne
Express whereby Airborne ships products to our customers. We believe that we
have negotiated favorable shipping rates with Airborne. We generally invoice
customers for shipping and handling charges. There can be no assurance that we
will be able to pass on to our customers the full cost, including any future
increases in the cost, of commercial delivery services such as Airborne.
25
We also incur substantial paper and postage costs related to our marketing
activities, including producing and mailing our catalogs. Paper prices
historically have been cyclical and we have experienced substantial increases
in the past. Significant increases in postal or shipping rates and paper costs
could adversely impact our business, financial condition and results of
operations, particularly if we cannot pass on such increases to our customers
or offset such increases by reducing other costs.
Privacy concerns with respect to list development and maintenance may
materially adversely affect our business.
We mail catalogs and send electronic messages to names in our proprietary
customer database and to potential customers whose names we obtain from rented
or exchanged mailing lists. World-wide 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 our
business.
We face many uncertainties relating to the collection of state sales or use tax.
We presently collect sales tax only on sales of products to residents of
Ohio, Tennessee, Maryland, the District of Columbia, Massachusetts and
Virginia. We began collecting sales tax in Massachusetts in January 2000.
Taxable sales to customers located within Ohio, Tennessee, Maryland, the
District of Columbia, Massachusetts and Virginia were approximately 7% of our
net sales during the year ended December 31, 2001. 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, our contact with many states may exceed the contact
involved in the Supreme Court case. We 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 us in states to which we ship products would
result in additional administrative expenses to us, could result in price
increases to our customers, and could reduce demand for our product.
We are dependent on key personnel.
Our future performance will depend to a significant extent upon the efforts
and abilities of our 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
our business. Our success and plans for future growth will also depend on our
ability to hire, train and retain skilled personnel in all areas of our
business, including sales account managers and technical support personnel.
There can be no assurance that we will be able to attract, train and retain
sufficient qualified personnel to achieve our business objectives.
We are controlled by two principal stockholders.
Patricia Gallup and David Hall, our two principal stockholders, beneficially
own or control, in the aggregate, approximately 71% of the outstanding shares
of our 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 our charter and our bylaws, or take other
actions requiring the vote or consent of our stockholders and prevent a
takeover of us by one or more third parties, or sell or otherwise transfer
their stock to a third party, which could deprive our stockholders of a control
premium that might otherwise be realized by them in connection with an
acquisition of us. Such control may result in decisions
26
that are not in the best interest of our public stockholders. In connection
with our initial public offering, the principal stockholders placed
substantially all 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 our common stock at a premium as well as have a negative
impact on the market price of our common stock.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
We invest cash balances in excess of operating requirements in short-term
securities, generally with maturities of 90 days or less. In addition, our
unsecured credit agreement provides for borrowings which bear interest at
variable rates based on the prime rate. We had no borrowings outstanding
pursuant to the credit agreement as of December 31, 2001. We believe that the
effect, if any, of reasonably possible near-term changes in interest rates on
our financial position, results of operations and cash flows should not be
material. Our credit agreement exposes earnings to changes in short-term
interest rates since interest rates on the underlying obligations are variable.
However, as noted above, there were no borrowings outstanding on the credit
agreement at December 31, 2001 and the average outstanding borrowings during
the year were not material. Accordingly, the change in earnings 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 PC Connection's definitive Proxy Statement
for our 2002 Annual Meeting of Stockholders to be held on May 23, 2002 (the
"Proxy Statement") is incorporated herein by reference. We anticipate filing
the Proxy Statement within 120 days after December 31, 2001. 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.
Page
Consolidated Financial Statements 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, as set forth
below, is filed with this report:
Page
Schedule Reference
-------- ---------
Schedule II-Valuation and Qualifying Accounts S-1
All other schedules have been omitted because they are either not
applicable or the relevant information has already been disclosed in the
financial statements.
(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.
EXHIBIT INDEX
Exhibits
- --------
*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.
28
Exhibits
- --------
*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 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.
*10.8 Employment Agreement between the Registrant and Wayne L. Wilson, dated August 16, 1995.
*10.9 Employment Agreement between the Registrant and Robert F. Wilkins, dated December 23, 1995.
*10.10 Letter Agreement between the Registrant and Airborne Freight Corporation D/B/A "Airborne
Express," dated April 30, 1990, as amended.
*10.11 Agreement between the Registrant and Ingram Micro, Inc., dated October 30, 1997, as amended.
*10.12 Employment Agreement, dated as of January 1, 1998, between the Registrant and Patricia Gallup.
*10.13 Form of Registration Rights Agreement among the Registrant, Patricia Gallup, David Hall and the
1998 PC Connection Voting Trust.
**10.14 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.
**10.15 Employment Agreement between the Registrant and John L. Bomba, dated March 28, 1997.
**10.16 Employment Agreement between the Registrant and Mark A. Gavin, dated February 5, 1998.
***10.17 Agreement for Wholesale Financing, dated as of March 25, 1998, between the Registrant and
Deutsche Financial Services Corporation.
***10.18 Amendment to 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 November 5, 1999, between the
Registrant and Deutsche Financial Services Corporation.
***10.20 Amendment to Agreement for Wholesale Financing, dated as of February 25, 2000 between the
Registrant and Deutsche Financial Services Corporation.
***10.21 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.
***10.22 Agreement for Inventory Financing, dated as of August 17, 1999, between the Registrant and IBM
Credit Corporation.
***10.23 Amendment to Agreement for Inventory Financing, dated as of February 25, 2000, between the
Registrant and IBM Credit Corporation.
***10.24 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.
***10.25 Agreement for Wholesale Financing, dated as of October 12, 1993, between ComTeq Federal, Inc.
and IBM Credit Corporation.
***10.26 Amendment to Agreement for Wholesale Financing, dated as of December 23, 1999, between
ComTeq Federal, Inc. and IBM Credit Corporation.
***10.27 Amendment to Addendum to Agreement for Wholesale Financing, dated as of December 23, 1999,
between ComTeq Federal, Inc. and IBM Credit Corporation.
***10.28 Amendment to Agreement for Wholesale Financing, dated as of February 25, 2000, between
ComTeq Federal, Inc. and IBM Credit Corporation.
29
Exhibits
--------
***10.29 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.
***10.30 Agreement for Wholesale Financing, dated as of February 25, 2000, between ComTeq Federal,
Inc. and Deutsche Financial Services Corporation.
***10.31 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.
***10.32 Assignment of Lease Agreements, dated as of December 13, 1999, between Micro Warehouse,
Inc. (assignor) and the Registrant (assignee).
***10.33 Amended and Restated Credit Agreement, dated February 25, 2000, between PC Connection,
Inc., the Lenders Party hereto and Citizens Bank of Massachusetts.
*****10.34 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.
****10.35 Lease between Merrimack Services Corporation and White Knight Realty Trust, dated
October 19, 2000 for property located at 7 Route 101A, Amherst, New Hampshire.
*****10.36 Amendment to Employment Agreement between the Registrant and Robert Wilkins dated
December 23, 1995.
*****10.37 Lease between Merrimack Services Corporation and Schleicher & Schuell, Inc., dated
November 16, 2000 for property located at 10 Optical Avenue, Keene, New Hampshire.
*****10.38 Lease between PC Connection Sales and Dover Mills L.P., dated May 1, 2000 for property
located at 100 Main Street, Dover, New Hampshire.
*****10.39 Lease between ComTeq Federal, Inc. and Rockville Office/Industrial Associates dated
December 14, 1993 for property located at 7503 Standish Place, Rockville, Maryland.
*****10.40 Amendment, dated November 1, 1996 to the Lease Agreement between ComTeq Federal, Inc.
and Rockville Office/Industrial Associates for property located in Rockville, Maryland.
*****10.41 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.
*****10.42 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.
*****10.43 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.
*****10.44 Lease between PC Connection, Inc. and The Hillsborough Group, dated January 5, 2000 for
property located at 706 Route 101A, Merrimack, New Hampshire.
******10.45 Amendment, dated December 27, 2000 to the Amended and Restated Credit Agreement, dated
February 25, 2000, between PC Connection, Inc., the Lender's Party hereto and Citizens Bank
of Massachusetts.
******10.46 Amendment, dated May 4, 2001 to the Amended and Restated Credit Agreement, dated
December 27, 2000, between PC Connection, Inc., the Lender's Party hereto and Citizens Bank
of Massachusetts.
******10.47 Amendments, dated June 19, 2001 to the Assignment of Lease Agreements, dated as of
December 13, 1999, between Micro Warehouse Inc. (assignor) and the Registrant (assignee).
30
Exhibits
- --------
10.48 Employment Agreement between the Registrant and Kenneth Koppel, dated June 25, 2001.
10.49 Amendment, dated August 22, 2001 to the Amended and Restated Credit Agreement, dated May 4,
2001, between PC Connection, Inc., the Lender's Party hereto and Citizens Bank of Massachusetts.
10.50(+) National Account Agreement between Airborne Express, Inc. and Merrimack Services Corporation
d/b/a PC Connection Services, dated September 10, 2001.
10.51 Agreement and Plan of Merger, dated March 25, 2002, by and among PC Connection, Inc., Boca
Acquisition Corp., MoreDirect, Inc. and the stockholders of MoreDirect, Inc. set forth on Schedule I
thereto.
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.
***** Incorporated by reference from exhibits filed with the Company's annual
report on Form 10-K, File Number 0-23827, filed on March 30, 2001.
****** Incorporated by reference from exhibits filed with the Company's
quarterly report on Form 10-Q, File Number 0-23827, filed on August 14,
2001.
(+) Confidential treatment requested for this agreement.
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.
Date: March 29, 2002
/s/ MARK A. GAVIN
By:__________________________________
Mark A Gavin
Chief Financial Officer
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/ JOSEPH BAUTE Director March 29, 2002
- -----------------------------
Joseph Baute
/s/ PETER J. BAXTER Director March 29, 2002
- -----------------------------
Peter J. Baxter
/s/ DAVID BEFFA-NEGRINI Director March 29, 2002
- -----------------------------
David Beffa-Negrini
/s/ PATRICIA GALLUP Chairman March 29, 2002
- -----------------------------
Patricia Gallup
/s/ MARK A. GAVIN Chief Financial Officer March 29, 2002
- ----------------------------- (Principal Financial and
Mark A. Gavin Accounting Officer)
/s/ DAVID HALL Vice Chairman and Director March 29, 2002
- -----------------------------
David Hall
/s/ KENNETH KOPPEL Chief Executive Officer March 29, 2002
- -----------------------------
Kenneth Koppel
/s/ MARTIN C. MURRER Director March 29, 2002
- -----------------------------
Martin C. Murrer
/s/ WAYNE L. WILSON President and COO March 29, 2002
- -----------------------------
Wayne L. Wilson
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, 2001 and 2000.................................... F-4
Consolidated Statements of Income for the years ended December 31, 2001, 2000, and 1999......... F-5
Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 2001,
2000, and 1999................................................................................ F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000, and 1999..... 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 its 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, the independent auditing firm, 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.
Kenneth Koppel Wayne L. Wilson Mark A. Gavin
Chief Executive Officer President and Senior Vice President
Chief Operating of Finance and
Officer Chief Financial Officer
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
PC Connection, Inc.
Merrimack, New Hampshire
We have audited the accompanying consolidated balance sheets of PC
Connection, Inc. and subsidiaries as of December 31, 2001 and 2000 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, 2001.
Our audits also included the financial statement schedule listed in the Index
at 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, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, 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.
Deloitte & Touche LLP
Boston, Massachusetts
January 24, 2002
March 25, 2002 as to Note 15
F-3
PC CONNECTION, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share data)
December 31,
------------------
2001 2000
-------- --------
ASSETS
Current Assets:
Cash and cash equivalents..................................................... $ 35,605 $ 7,363
Accounts receivable, net...................................................... 117,461 139,644
Inventories - merchandise..................................................... 48,003 54,679
Deferred income taxes......................................................... 2,304 2,175
Income taxes receivable....................................................... 1,312 4,882
Prepaid expenses and other current assets..................................... 3,013 3,064
-------- --------
Total current assets........................................................ 207,698 211,807
Property and equipment, net.................................................... 27,472 28,665
Goodwill, net.................................................................. 8,807 9,509
Other assets................................................................... 258 432
-------- --------
Total Assets................................................................ $244,235 $250,413
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease obligation to affiliate................... $ 171 $ 153
Current maturities of long-term debt.......................................... 1,000 1,000
Accounts payable.............................................................. 75,399 86,216
Accrued expenses and other liabilities........................................ 10,272 12,769
-------- --------
Total current liabilities................................................... 86,842 100,138
Long-term debt, less current maturities........................................ -- 1,000
Capital lease obligation to affiliate, less current maturities................. 6,621 6,792
Deferred income taxes.......................................................... 3,523 3,555
Other liabilities.............................................................. 73 241
-------- --------
Total Liabilities........................................................... 97,059 111,726
-------- --------
Commitments and Contingencies (Note 11)
Stockholders' Equity:
Preferred Stock, $.01 par value, 10,000 shares authorized, 0 issued and
outstanding at December 31, 2001 and December 31, 2000.................... -- --
Common Stock, $.01 par value, 100,000 shares authorized, 24,748
and 24,416 issued, 24,543 and 24,416 outstanding at December 31, 2001 and
December 31, 2000, respectively........................................... 247 244
Additional paid-in capital.................................................... 74,393 71,542
Retained earnings............................................................. 74,073 66,901
Treasury stock at cost........................................................ (1,537) --
-------- --------
Total Stockholders' Equity.................................................. 147,176 138,687
-------- --------
Total Liabilities and Stockholders' Equity.................................. $244,235 $250,413
======== ========
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,
----------------------------------
2001 2000 1999
---------- ---------- ----------
Net sales............................................... $1,180,951 $1,449,908 $1,080,835
Cost of sales........................................... 1,049,799 1,273,687 951,489
---------- ---------- ----------
Gross Profit........................................... 131,152 176,221 129,346
Selling, general and administrative expenses............ 117,508 123,972 91,405
Restructuring costs and other special charges........... 2,204 -- --
---------- ---------- ----------
Income from operations................................. 11,440 52,249 37,941
Interest expense........................................ (1,179) (2,086) (1,392)
Other, net.............................................. 1,307 589 116
---------- ---------- ----------
Income before taxes..................................... 11,568 50,752 36,665
Income taxes............................................ (4,396) (19,289) (13,935)
---------- ---------- ----------
Net income............................................. $ 7,172 $ 31,463 $ 22,730
========== ========== ==========
Earnings per common share:
Basic.................................................. $ .29 $ 1.31 $ .97
========== ========== ==========
Diluted................................................ $ .29 $ 1.23 $ .94
========== ========== ==========
Shares used in computation of earnings per common share:
Basic.................................................. 24,453 24,054 23,475
========== ========== ==========
Diluted................................................ 24,947 25,572 24,167
========== ========== ==========
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 Treasury Shares
------------- Paid-In Retained --------------
Shares Amount Capital Earnings Shares Amount Total
------ ------ ---------- -------- ------ ------- --------
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 and comprehensive 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 and comprehensive income........ -- -- -- 31,463 -- -- 31,463
------ ---- ------- ------- ---- ------- --------
Balance, December 31, 2000................. 24,416 244 71,542 66,901 -- -- 138,687
------ ---- ------- ------- ---- ------- --------
Exercise of stock options, including income
tax benefits............................. 197 2 1,379 -- -- -- 1,381
Issuance of stock under employee stock
purchase plan............................ 135 1 1,472 -- -- -- 1,473
Net income and comprehensive income........ -- -- -- 7,172 -- -- 7,172
Repurchase of common stock for Treasury.... -- -- -- -- (205) (1,537) (1,537)
------ ---- ------- ------- ---- ------- --------
Balance, December 31, 2001................. 24,748 $247 $74,393 $74,073 (205) $(1,537) $147,176
====== ==== ======= ======= ==== ======= ========
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,
------------------------------
2001 2000 1999
- - -------- --------- ---------
Cash Flows from Operating Activities:
Net income............................................................ $ 7,172 $ 31,463 $ 22,730
Adjustments to reconcile net income to net cash provided by (used for)
operating activities:
Depreciation and amortization....................................... 7,815 6,566 5,334
Deferred income taxes............................................... (500) 1,540 2,153
Compensation under nonstatutory stock option agreements............. -- 51 162
Provision for doubtful accounts..................................... 10,680 9,868 6,821
(Gain)/loss on disposal of fixed assets............................. (174) (13) 159
Changes in assets and liabilities:
Accounts receivable................................................. 11,503 (49,607) (42,795)
Inventories......................................................... 6,676 9,669 (305)
Prepaid expenses and other current assets........................... 3,621 (3,295) (504)
Other non-current assets............................................ 139 (263) --
Accounts payable.................................................... (10,817) (19,077) 19,945
Income tax benefits from exercise of stock options.................. 242 8,193 370
Accrued expenses and other liabilities.............................. (2,184) 897 1,969
-------- --------- ---------
Net cash provided by (used for) operating activities.................. 34,173 (4,008) 16,039
-------- --------- ---------
Cash Flows from Investing Activities:
Purchases of property and equipment................................... (6,122) (12,581) (7,653)
Proceeds from sale of property and equipment.......................... 269 2,074 2,155
Payment for acquisitions, net of cash acquired........................ -- (2,158) (3,198)
-------- --------- ---------
Net cash used for investing activities................................ (5,853) (12,665) (8,696)
-------- --------- ---------
Cash Flows from Financing Activities:
Proceeds from short-term borrowings................................... 44,955 583,042 442,731
Repayment of short-term borrowings.................................... (44,955) (583,042) (442,731)
Repayment of notes payable............................................ (1,000) (1,000) --
Repayment of capital lease obligation to affiliate.................... (153) (137) (122)
Exercise of stock options............................................. 1,139 3,825 814
Issuance of stock under employee stock purchase plan.................. 1,473 932 471
Purchase of treasury shares........................................... (1,537) -- --
-------- --------- ---------
Net cash provided by (used for) financing activities.................. (78) 3,620 1,163
-------- --------- ---------
Increase (decrease) in cash and cash equivalents...................... 28,242 (13,053) 8,506
Cash and cash equivalents, beginning of year.......................... 7,363 20,416 11,910
-------- --------- ---------
Cash and cash equivalents, end of year................................ $ 35,605 $ 7,363 $ 20,416
======== ========= =========
Supplemental Cash Flow Information:
Interest paid......................................................... $ 1,092 $ 1,923 $ 1,398
Income taxes paid..................................................... 2,818 13,242 9,374
Non-Cash Activities:
Issuance of notes payable in connection with acquisition of subsidiary $ -- $ -- $ 3,000
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, except for sales
to federal agencies, for which delivery occurs at destination. The Company
provides its customers with a limited thirty day right of return only for
defective merchandise. Revenue is recognized at delivery 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, "Revenue Recognition When Right of Return Exists", based on significant
historical experience.
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 have
been classified as "net sales." Costs related to such shipping and handling
billings are classified as "cost of sales."
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.
Accounts Receivable
Ongoing credit evaluations of the Company's customers are performed, and
credit limits are adjusted, based on payment history and customer
credit-worthiness. An allowance for estimated doubtful accounts is maintained
based on the Company's historical experience and the customer credit issues
identified. Collections are monitored regularly, and the allowance is adjusted
as necessary to recognize any changes in credit exposure.
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. Inventory quantities
on hand are reviewed regularly, and provisions are made for obsolete, slow
moving and nonsalable inventory.
F-8
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 and are offset against selling, general and
administrative expense on the consolidated statements of income.
Advertising costs charged to expense were $25,847, $27,159, and $31,487 for
the years ended December 31, 2001, 2000 and 1999, respectively. Deferred
advertising revenues at December 31, 2001, 2000 and 1999 exceeded deferred
advertising costs by $228, $110, and $423 at those respective dates.
Comprehensive Income
There are no other elements of comprehensive income in the three years ended
December 31, 2001 apart from net income as reported.
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 2001, 2000 and 1999 was $738, $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. (See
"Recently Issued Financial Accounting Pronouncements" below in Note 1 for a
discussion of the Company's adoption of SFAS 142.)
Income Taxes
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.
F-9
Concentrations
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.
During the years ended December 31, 2001 and 2000, product purchases from
Ingram Micro, Inc., the Company's largest vendor, accounted for approximately
24.7% and 25.6%, respectively, of its total product purchases. Purchases from
Tech Data Corporation comprised 14.1% and 11.2% of the Company's total
purchases in the years ended December 31, 2001 and 2000, respectively. No other
vendor accounted for more than 10% of the Company's total product purchases.
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 for the incremental
shares attributed to outstanding options to purchase common stock where such
options have a dilutive effect on earnings per share.
The following table sets forth the computation of basic and diluted earnings
per share:
2001 2000 1999
------- ------- -------
Numerator:
Net income............................... $ 7,172 $31,463 $22,730
======= ======= =======
Denominator:
Denominator for basic earnings per share. 24,453 24,054 23,475
Effect of dilutive securities:
Employee stock options................... 494 1,518 692
------- ------- -------
Denominator for diluted earnings per share 24,947 25,572 24,167
======= ======= =======
Earnings per share:
Basic.................................... $ .29 $ 1.31 $ .97
======= ======= =======
Diluted.................................. $ .29 $ 1.23 $ .94
======= ======= =======
The following options to purchase Common Stock were excluded from the
computation of diluted earnings per share for years ended December 31, 2001,
2000, and 1999 because the effect of the options on the calculation would have
been anti-dilutive:
2001 2000 1999
---- ---- ----
Anti-dilutive stock options 868 97 --
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, "Accounting for Stock Issued to Employees". Disclosures
concerning the impact of the utilization of the fair market value model
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation", appear
in Note 8.
Restructuring Costs and Other Special Charges
On March 28, 2001, the Company announced the reduction of non-sales staff by
approximately 125 individuals, or 7.5% of the Company's work force. The Company
took a charge of approximately $0.9 million in
F-10
the first quarter of 2001 to cover costs related to this staff reduction. This
staff reduction was completed in early April 2001. The Company took a charge in
the third quarter of 2001 to cover costs related to additional staff reductions
of $0.5 million and to cover $0.7 million of costs associated with proposed
acquisitions abandoned during the quarter. All third-quarter staff reductions
were completed by September 30, 2001. The Company took a charge in the fourth
quarter of 2001 to cover costs related to additional staff reductions of $0.1
million. This is reflected under the caption, "restructuring costs and other
special charges" on the consolidated statements of income for the year ended
December 31, 2001. Liabilities at December 31, 2001 are included in accrued
expenses and other liabilities on the balance sheet.
A rollforward of restructuring costs and other special charges for the
twelve months ended December 31, 2001 is shown below. There were no changes in
estimates in the interim periods.
Liabilities at
Total Charges Cash Payments December 31, 2001
------------- ------------- -----------------
Workforce Reduction........................ $1,510 $(1,085) $425
Cost Associated with Abandoned Acquisitions 694 (694) 0
------ ------- ----
$2,204 $(1,779) $425
====== ======= ====
Share Repurchase Authorization
The Company announced on March 28, 2001 that its Board of Directors
authorized the spending of up to $15.0 million to repurchase the Company's
common stock. Share purchases will be made in the open market from time to time
depending on market conditions. The Company has repurchased 205,000 shares
for $1.5 million as of December 31, 2001, which are reflected as treasury stock
on the consolidated balance sheet.
Recently Issued Financial Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for business
combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. The Company does not believe that the adoption of
SFAS 141 will have a significant impact on its financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is
effective for the Company on January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of the amortization of goodwill and certain other
identified intangibles. In addition, the statement includes provisions for the
reassessment of the value and useful lives of existing recognized intangibles
(including goodwill), reclassification of certain intangibles both in and out
of previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill and other
intangibles. The Company believes the impact of adopting this statement will
not be material to the balance sheet. The Company had recorded $738 in
amortization relative to goodwill in 2001. This amortization will cease in 2002
with the adoption of SFAS 142.
Reclassifications
Certain amounts in the 2000 and 1999 financial statements have been
reclassified to conform to the 2001 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 is currently amortized over a period of 15
years. (See Note 1 for a discussion of the Company's adoption of SFAS 142.)
F-11
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 is currently amortized over a period of 15 years. (See Note 1 for a
discussion of the Company's adoption of SFAS 142). 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, 2001, the short-term
portion of the promissory notes was $1,000 and the long-term portion was zero.
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.
Year Ended
December 31, 1999
-----------------
Revenues.................. $1,105,664
Net income................ 23,350
Diluted earnings per share .97
3. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
December 31,
------------------
2001 2000
-------- --------
Trade............................ $115,739 $134,682
Co-op advertising................ 6,242 4,243
Vendor returns, rebates and other 4,657 9,847
-------- --------
Total....................... 126,638 148,772
Less allowances for:
Sales returns............... (1,745) (3,592)
Doubtful accounts........... (7,432) (5,536)
-------- --------
Accounts receivable, net......... $117,461 $139,644
======== ========
F-12
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
December 31,
------------------
2001 2000
-------- --------
Facilities under capital lease......................................... $ 7,215 $ 7,215
Leasehold improvements................................................. 5,406 4,730
Furniture and equipment................................................ 27,166 25,711
Computer software, including licenses and internally-developed software 22,050 18,645
Automobiles............................................................ 269 266
-------- --------
Total............................................................. 62,106 56,567
Less accumulated depreciation and amortization......................... (34,634) (27,902)
-------- --------
Property and equipment, net............................................ $ 27,472 $ 28,665
======== ========
5. BANK BORROWINGS
At December 31, 2001, 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 (4.75% at December 31, 2001) 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, 2001. The credit agreement matures on May 31, 2002.
The Company is currently renegotiating the credit agreement.
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,
2001.............. 5.9% $ 6,267 $ 197
2000.............. 8.2 55,000 9,567
1999.............. 7.4 29,543 4,497
6. TRADE CREDIT ARRANGEMENTS
At December 31, 2001 and 2000, 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, 2001 and 2000, accounts
payable included $6,374 and $12,136, respectively owed to these financial
institutions.
7. CAPITAL LEASE
In November 1997, the Company entered into a fifteen-year lease for its
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.
F-13
Annual lease payments under the terms of the lease, as amended, are
approximately $911 for the first five 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.
The net book value of capital lease assets was $5,732 and $6,213 as of
December 31, 2001 and 2000, respectively.
Future aggregate minimum annual lease payments under this lease at December
31, 2001 are as follows:
Year Ending December 31 Payments
----------------------- --------
2002............................................................... $ 911
2003............................................................... 921
2004............................................................... 1,025
2005............................................................... 1,025
2006............................................................... 1,025
2007 and thereafter................................................ 7,663
-------
Total minimum payments (excluding taxes, maintenance and insurance) 12,570
Less amount representing interest.................................. (5,778)
-------
Present value of minimum lease payments............................ 6,792
Less current maturities............................................ (171)
-------
Long-term portion.................................................. $ 6,621
=======
8. STOCKHOLDERS' EQUITY
Preferred Stock
The Company's Amended and Restated Certificate of Incorporation (the
"Restated Certificate") authorized the issuance of up to 10,000,000 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 2001 and 2000.
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 Company's initial public offering in 1998. 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 3,600,000 shares have been reserved for issuance
under this Plan.
F-14
Information regarding the 1993 and 1997 Plans is as follows:
Weighted Weighted
Average Average
Option Exercise Fair
Shares Price Value
--------- -------- --------
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
---------
Granted.................. 776,367 13.01 9.14
Exercised................ (197,134) 5.78
Forfeited................ (334,929) 18.53
---------
Outstanding December 31, 2001. 2,893,812 13.40
=========
The following table summarizes the status of outstanding stock options as of
December 31, 2001:
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
----------- --------- ------------ -------------- --------- --------------
$.51 315,693 2.32 $ .51 315,693 $ .51
$3.81 117,244 4.34 3.81 117,244 3.81
$8.92 274,845 7.73 8.92 117,496 8.92
$9.98 5,000 8.96 9.98 1,250 9.98
$10.10 57,500 9.80 10.10 0 0
$10.81 151,641 9.21 10.81 0 0
$10.99 21,250 9.63 10.99 0 0
$11.67 925,298 5.87 11.67 727,563 11.67
$11.83--$16.83 546,936 9.31 14.10 8,248 13.01
$18.33 196,891 8.06 18.33 49,272 18.33
$20.33--$34.83 122,500 8.38 23.01 32,500 22.85
$51.81 141,014 8.54 51.81 36,287 51.81
$52.75--$62.19 18,000 8.64 53.54 4,500 53.54
-------------- --------- ---- ------ --------- -------
$.51--$62.19 2,893,812 6.77 $13.40 1,410,053 $ 9.97
============== ========= ==== ====== ========= =======
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 2001, 2000 and 1999, has been recognized
using the intrinsic value method.
The fair value of options granted prior to the consummation of the Company's
initial public offering in 1998 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.
F-15
The Black-Scholes model was used to value options granted subsequent to the
Offering using a volatility factor of 98.8%, 69%, and 50% for 2001, 2000 and
1999, respectively, estimated option lives of four years, and a risk-free
interest rate of 4% for 2001, 6.4% for 2000, and 6% for 1999. 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.
Compensation expense charged to operations using the intrinsic value method
totaled $0, $51 and $162 for the years ended December 31, 2001, 2000, and 1999,
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:
2001 2000 1999
------ ------- -------
Net income, as reported.................. $7,172 $31,463 $22,730
Net income, under SFAS No. 123........... 4,849 29,414 21,511
Diluted net income per share, as reported .29 1.23 .94
Diluted net income, under SFAS No. 123... .20 1.15 .89
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 279,152 shares were
purchased.
9. INCOME TAXES
The 2001, 2000 and 1999 provision for income taxes consisted of the
following:
Years Ended December 31,
------------------------
2001 2000 1999
------ ------- -------
Paid or currently payable:
--------------------------
Federal.................. $4,510 $16,673 $10,373
State.................... 386 1,526 1,409
------ ------- -------
Total current.......... 4,896 18,199 11,782
------ ------- -------
Deferred:
Federal.................. (460) 1,004 1,983
State.................... (40) 86 170
------ ------- -------
Net deferred........... (500) 1,090 2,153
------ ------- -------
Net provision.......... $4,396 $19,289 $13,935
====== ======= =======
The components of the deferred taxes at December 31, 2001 and 2000 are as
follows:
2001 2000
------- -------
Current:
--------
Provisions for doubtful accounts....................... $ 2,824 $ 2,104
Inventory costs capitalized for tax purposes........... 93 442
Inventory and sales returns reserves................... 586 887
Deductible expenses, primarily employee-benefit related 120 61
Other liabilities...................................... (1,319) (1,319)
------- -------
Net deferred tax asset................................. 2,304 2,175
------- -------
F-16
2001 2000
------- -------
Non-Current:
- ------------
Compensation under non-statutory stock option agreements..... 409 426
Excess of book basis over tax basis of property and equipment (3,932) (3,981)
------- -------
Net deferred tax liability................................... (3,523) (3,555)
------- -------
Net deferred tax (liability)................................. $(1,219) $(1,380)
======= =======
The reconciliation of the Company's 2001, 2000 and 1999 income tax provision
to the statutory federal tax rate is as follows:
2001 2000 1999
---- ---- ----
Statutory tax rate........................ 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 3.0 2.5 2.6
Nondeductible expenses.................... 0.1 0.4 0.2
Other--net................................ (0.1) 0.1 0.2
---- ---- ----
Effective income tax rate................. 38.0% 38.0% 38.0%
==== ==== ====
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 2001, 2000 or 1999. The Company
made matching contributions to the employee savings element of the plan of
$513, $592 and $317 in 2001, 2000 and 1999, 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, distribution facilities and
equipment from unrelated parties with remaining terms of one to six years.
Future aggregate minimum annual lease payments under these leases at
December 31, 2001 are as follows:
Year Ending December 31 Related Parties Others Total
----------------------- --------------- ------ ------
2002................. $179 $5,405 $5,584
2003................. 149 3,134 3,283
2004................. 134 2,017 2,151
2005................. 134 191 325
2006................. 134 29 163
2007 and thereafter.. 204 -- 204
Total rent expense aggregated $5,656, $3,936 and $1,470 for the years ended
December 31, 2001, 2000 and 1999, respectively, under the terms of the leases
described above. Such amounts included $179, $169 and $189 in 2001, 2000 and
1999, 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.
F-17
12. OTHER RELATED PARTY TRANSACTIONS
As described in Notes 7 and 11, the Company has leased certain facilities
from related parties. Other related-party transactions include the transactions
summarized below. Related parties consist primarily of affiliated companies
related to the Company through common ownership.
Years Ended December 31
-----------------------
2001 2000 1999
---- ---- ----
Revenue:
Sales of various products..................... $ 3 $ 3 $ 1
Sales of services to affiliated companies..... 148 300 332
Costs:
Purchase of services from affiliated companies 1 9 6
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).
Net sales by platform, sales channel, and product mix are presented below:
Years Ended December 31,
--------------------------------
2001 2000 1999
---------- ---------- ----------
Platform
--------
PC and Multi Platform.... $1,061,700 $1,300,453 $ 919,543
Mac...................... 119,251 149,455 161,292
---------- ---------- ----------
Total................ $1,180,951 $1,449,908 $1,080,835
========== ========== ==========
Sales Channel
-------------
Corporate Outbound....... $ 937,846 $1,099,879 $ 705,580
Inbound Telesales........ 140,196 237,013 314,622
On-Line Internet......... 102,909 113,016 60,633
---------- ---------- ----------
Total................ $1,180,951 $1,449,908 $1,080,835
========== ========== ==========
Product Mix
-----------
Notebooks................ $ 255,043 $ 365,067 $ 250,801
Desktop/Servers.......... 145,951 211,505 165,325
Storage Devices.......... 115,813 139,406 109,675
Software................. 158,486 149,982 129,484
Networking Communications 107,028 113,022 69,065
Printers................. 97,205 103,125 99,287
Video & Monitors......... 106,159 117,602 81,805
Memory................... 33,544 58,465 38,318
Accessories/Other........ 161,722 191,734 137,075
---------- ---------- ----------
Total................ $1,180,951 $1,449,908 $1,080,835
========== ========== ==========
F-18
Included in the product mix sales are enterprise networking product sales of
$234,000, $253,000 and $125,000 for the years ended December 2001, 2000 and
1999, respectively.
Substantially, all of the Company's net sales in 2001, 2000 and 1999 were
made to customers located in the United States. Shipments to customers located
in foreign countries aggregated less than 2% in 2001, 2000 and 1999. All of the
Company's assets at December 31, 2001 and 2000 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 2001.
Net sales to the federal government in 2001, 2000 and 1999 were $164.2 million,
$129.2 million and $81.4 million, or 13.9%, 8.9% and 7.5% of total net sales,
respectively.
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 2000. This information has been
prepared on the same basis as the annual financial statements and all necessary
adjustments, consisting only of normal recurring adjustments, have been
included in the amounts stated below to present fairly the selected quarterly
information when read in conjunction with the annual financial statements and
the notes thereto included elsewhere in this document. The quarterly operating
results are not necessarily indicative of future results of operations. See
"Factors That May Affect Future Results and Financial Condition--Historical Net
Losses; Variability of Quarterly Results."
Quarters Ended
--------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
2001 2001 2001 2001
--------- -------- --------- --------
Net sales.................................... $301,775 $297,338 $308,689 $273,149
Cost of sales................................ 266,450 264,486 275,454 243,409
-------- -------- -------- --------
Gross profit............................ 35,325 32,852 33,235 29,740
Selling, general and administrative expenses. 30,463 30,653 29,038 27,354
Restructuring costs and other special charges 851 -- 1,200 153
-------- -------- -------- --------
Income from operations.................. 4,011 2,199 2,997 2,233
Interest expense............................. (377) (277) (264) (261)
Other, net................................... 288 396 357 266
-------- -------- -------- --------
Income before income taxes................... 3,922 2,318 3,090 2,238
Income tax provision......................... (1,489) (882) (1,174) (851)
-------- -------- -------- --------
Net Income.............................. $ 2,433 $ 1,436 $ 1,916 $ 1,387
======== ======== ======== ========
Weighted average common shares outstanding:
Basic................................... 24,417 24,422 24,506 24,467
======== ======== ======== ========
Diluted................................. 24,931 24,994 24,921 24,931
======== ======== ======== ========
Earnings per common share:
Basic................................... $ .10 $ .06 $ .08 $ .06
======== ======== ======== ========
Diluted................................. $ .10 $ .06 $ .08 $ .06
======== ======== ======== ========
F-19
Quarters Ended
--------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
2000 2000 2000 2000
--------- -------- --------- --------
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
======== ======== ======== ========
15. SUBSEQUENT EVENT
On March 25, 2002, the Company signed a definitive agreement to acquire all
of the outstanding stock of MoreDirect, Inc., an e-procurement supplier of
information technology products for medium to large corporate and government
organizations nationwide. Under the terms of the agreement, the Company will
pay the shareholders of MoreDirect Inc., $21,000 in cash at closing. In
addition, PC Connection will pay additional cash to the MoreDirect shareholders
based upon MoreDirect achieving targeted levels of annual earnings before
income taxes through December 31, 2004. PC Connection will also escrow $10,000
in cash at closing to fund a portion of these contingent payments. The
transaction will be accounted for by the purchase method, and accordingly, that
company's results of operations will be included in the Company's consolidated
financial statements only for periods after the date of closing. For 2001,
MoreDirect reported net sales and pre-tax income of $219,000 and $9,200,
respectively.
F-20
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, 1999.. $4,030 $68,215 $(68,528) $3,717
Year Ended December 31, 2000.. 3,717 67,321 (67,446) 3,592
Year Ended December 31, 2001.. 3,592 52,969 (54,816) 1,745
Allowance for Doubtful Accounts
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
Year Ended December 31, 2001.. 5,536 10,680/(1)/ (8,784) 7,432
Inventory Valuation Reserve
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
Year Ended December 31, 2001.. 1,700 5,808 (6,308) 1,200
- --------
/(1)/ Additions to the provision for doubtful accounts include charges to
advertising and cost of sales aggregating $1,981, $2,863 and $13,037 for
the years ended December 31, 2001, 2000, and 1999, respectively. Such
allowances relate to receivables under cooperative arrangements with
vendors.
S-1