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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission file number 0-23827
PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 02-0513618
-------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
730 MILFORD ROAD,
MERRIMACK, NEW HAMPSHIRE 03054
- ---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (603) 423-2000
--------------
Indicate by check mark [X] 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 _____
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of November 11, 2002 was 24,584,548.
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PC CONNECTION, INC. AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION Page
--------------------- ----
Item 1 Financial Statements:
Independent Accountants' Report ...................................................... 1
Condensed Consolidated Balance Sheets - September 30, 2002
and December 31, 2001 ............................................................. 2
Condensed Consolidated Statements of Income -
Three months ended September 30, 2002 and 2001;
Nine months ended September 30, 2002 and 2001 ..................................... 3
Condensed Consolidated Statement of Changes in Stockholders' Equity - Nine
months ended September 30, 2002 ................................................... 4
Condensed Consolidated Statements of Cash Flows - Nine months
ended September 30, 2002 and 2001 ................................................. 5
Notes to Condensed Consolidated Financial Statements ................................. 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................................... 13
Item 3 Quantitative and Qualitative Disclosures About Market Risk ........................... 25
Item 4 Controls and Procedures .............................................................. 26
PART II OTHER INFORMATION
-----------------
Item 1 Legal Proceedings .................................................................... 27
Item 2 Changes in Securities and Use of Proceeds ............................................ 27
Item 3 Defaults Upon Senior Securities ...................................................... 27
Item 4 Submission of Matters to a Vote of Security Holders .................................. 27
Item 5 Other Information .................................................................... 27
Item 6 Exhibits and Reports on Form 8-K ..................................................... 27
SIGNATURES ........................................................................... 28
----------
CERTIFICATIONS ....................................................................... 29
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INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of
PC Connection, Inc.
Merrimack, New Hampshire
We have reviewed the accompanying condensed consolidated balance sheet of PC
Connection, Inc. and subsidiaries (the "Company") as of September 30, 2002,
and the related condensed consolidated statements of income for the three-month
and nine-month periods ended September 30, 2002 and 2001 and the condensed
consolidated statement of changes in stockholders' equity for the nine-month
period ended September 30, 2002, and the condensed consolidated statements of
cash flows for the nine-month periods ended September 30, 2002 and 2001. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of PC
Connection, Inc. and subsidiaries as of December 31, 2001, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended (not presented herein); and in our report dated January 24, 2002
(March 25, 2002 as to Note 15 and October 11, 2002 as to Note 16), we expressed
an unqualified opinion with an explanatory paragraph relating to the restatement
on those consolidated financial statements. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheet as of December
31, 2001 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
October 24, 2002
-1-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
- ---------------------------------------------------------------------------------------------------------------
September 30, December 31,
- ---------------------------------------------------------------------------------------------------------------
2002 2001
- ---------------------------------------------------------------------------------------------------------------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 13,862 $ 35,605
Accounts receivable, net 142,628 107,163
Inventories-merchandise 52,774 57,456
Deferred income taxes 3,203 2,559
Income taxes receivable 3,037 1,312
Prepaid expenses and other current assets 2,483 3,013
----------- -----------
Total current assets 217,987 207,108
Property and equipment, net 27,464 27,472
Goodwill, net and other intangibles, net 26,738 8,807
Restricted cash 10,000 -
Other assets 381 258
----------- -----------
Total assets $ 282,570 $ 243,645
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease obligation to affiliate $ 185 $ 171
Current maturities of long-term debt - 1,000
Accounts payable 111,146 75,399
Accrued expenses and other liabilities 14,139 10,096
----------- -----------
Total current liabilities 125,470 86,666
Capital lease obligation to affiliate, less current maturities 6,481 6,621
Deferred income taxes 3,643 3,523
Other liabilities 16 73
----------- -----------
Total liabilities 135,610 96,883
----------- -----------
Stockholders' Equity:
Common stock 249 247
Additional paid-in capital 74,957 74,393
Retained earnings 74,042 73,659
Treasury stock at cost (2,288) (1,537)
----------- -----------
Total stockholders' equity 146,960 146,762
----------- -----------
Total liabilities and stockholders' equity $ 282,570 $ 243,645
=========== ===========
See accompanying notes to condensed consolidated financial statements.
-2-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(amounts in thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Net sales $ 341,039 $ 312,885 $ 869,347 $ 912,581
Cost of sales 303,869 279,352 775,903 810,873
----------- ----------- ----------- -----------
Gross profit 37,170 33,533 93,444 101,708
Selling, general and administrative expenses 32,625 29,117 90,712 90,210
Restructuring costs and other special charges 718 1,200 1,636 2,051
----------- ----------- ----------- -----------
Income from operations 3,827 3,216 1,096 9,447
Interest expense (297) (264) (835) (918)
Other, net 94 357 421 1,041
Income tax provision (1,418) (1,257) (299) (3,636)
----------- ----------- ----------- -----------
Net income $ 2,206 $ 2,052 $ 383 $ 5,934
=========== =========== =========== ===========
Weighted average common shares outstanding:
Basic 24,533 24,506 24,546 24,449
=========== =========== =========== ===========
Diluted 24,789 24,921 24,848 24,952
=========== =========== =========== ===========
Earnings per common share:
Basic $ .09 $ .08 $ .02 $ .24
=========== =========== =========== ===========
Diluted $ .09 $ .08 $ .02 $ .24
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
-3-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Nine months Ended September 30, 2002
(Unaudited)
(amounts in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Common Stock Treasury Shares
------------ Additional Retained ---------------
Shares Amount Paid In Capital Earnings Shares Amount Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance - December 31, 2001 24,748 $ 247 $ 74,393 $ 73,659 (205) $ (1,537) $ 146,762
Exercise of stock options, including
income tax benefits 78 1 252 - - - 253
Issuance of stock under employee
stock purchase plan 89 1 312 - - - 313
Repurchase of common stock
for treasury - - - - (156) (751) (751)
Net income - - - 383 - - 383
------- ------- --------- -------- ------ -------- ---------
Balance - September 30, 2002 24,915 $ 249 $ 74,957 $ 74,042 (361) $ (2,288) $ 146,960
======= ======= ========= ======== ====== ======== =========
See accompanying notes to condensed consolidated financial statements.
-4-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in thousands)
- ----------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30,
- ----------------------------------------------------------------------------------------------------------------
2002 2001
- ----------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 383 $ 5,934
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 5,997 5,763
Deferred income taxes (524) 42
Provision for doubtful accounts 5,838 8,590
Loss on disposal of fixed assets - 9
Changes in assets and liabilities:
Accounts receivable (12,392) 14,829
Inventories 5,000 18,082
Prepaid expenses and other current assets (865) 5,633
Other non-current assets (95) 191
Income tax benefits from exercise of stock options 118 156
Accounts payable 12,845 (5,692)
Accrued expenses and other liabilities 378 (1,513)
---------- ----------
Net cash provided by operating activities 16,683 52,024
---------- ----------
Cash Flows from Investing Activities:
Purchases of property and equipment (4,428) (4,860)
Proceeds from sale of property and equipment 16 16
Payments for acquisitions, net of cash acquired (22,585) -
Cash escrow funded for acquisition (10,000) -
---------- ----------
Net cash used for investing activities (36,997) (4,844)
---------- ----------
Cash Flows from Financing Activities:
Proceeds from short-term borrowings 19,568 67,952
Repayment of short-term borrowings (19,568) (67,952)
Repayment of notes payable (1,000) (1,000)
Repayment of capital lease obligation to affiliate (126) (113)
Exercise of stock options 135 615
Issuance of stock under employee stock purchase plan 313 728
Purchase of treasury shares (751) (1,497)
---------- ----------
Net cash used for financing activities (1,429) (1,267)
---------- ----------
(Decrease)/increase in cash and cash equivalents (21,743) 45,913
Cash and cash equivalents, beginning of period 35,605 7,363
---------- ----------
Cash and cash equivalents, end of period $ 13,862 $ 53,276
========== ==========
See accompanying notes to condensed consolidated financial statements.
-5-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Note 1-Basis of Presentation
- --------------------------------------------------------------------------------
The accompanying condensed consolidated financial statements of PC Connection,
Inc. and Subsidiaries ("PCC") have been prepared in accordance with accounting
principles generally accepted in the United States of America. Such principles
were applied on a basis consistent with those of the financial statements
contained in our Annual Report on Form 10-K/A for the year ended December 31,
2001 filed with the Securities and Exchange Commission ("SEC"). The accompanying
condensed consolidated financial statements should be read in conjunction with
the financial statements contained in our Annual Report on Form 10-K/A. In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation. The operating results
for the three and nine months ended September 30, 2002 may not be indicative of
the results expected for any succeeding quarter or the entire year ending
December 31, 2002.
In June 2001, we adopted Statement of Financial Accounting Standards ("SFAS")
No. 141, "Business Combinations." The principles set forth in this standard were
applied to our acquisition of MoreDirect described in Note 7 to the condensed
consolidated financial statements. Previous business combinations had been
accounted for under Accounting Principles Board Opinion No. 16. There was no
effect on the financial statements when the standard was adopted. We adopted
SFAS No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. SFAS
No. 142 required, among other things, the discontinuance of the amortization of
goodwill and certain other identified intangibles. It also required a January 1,
2002 reassessment of the recoverability of the goodwill that was carried on our
financial statements. SFAS No. 142 also 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
completed the initial impairment review required by SFAS No. 142 in June 2002
and have determined that our goodwill and intangible assets were not impaired.
We intend to perform our annual impairment tests relative to goodwill on January
1 of each year. We have ceased amortization of goodwill in 2002. The following
is a reconciliation of reported net income to adjusted net income for the three
and nine months ended September 30, 2002 and 2001, taking into account the
cessation of goodwill amortization:
-------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended Ended
-------------------------------------------------------------------------------------------------------------------------
September 30, (amounts in thousands, except per share data) 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------------------
Reported net income $ 2,206 $ 2,052 $ 383 $ 5,934
Add back goodwill amortization (net of taxes) - 109 - 327
-------- ------- --------- -------
Adjusted net income $ 2,206 $ 2,161 $ 383 $ 6,261
======== ======= ========= =======
Diluted earnings per share:
Reported net income $ .09 $ .08 $ .02 $ .24
Add back goodwill amortization (net of taxes) - .01 - .01
-------- ------- --------- --------
Adjusted net income $ .09 $ .09 $ .02 $ .25
======== ======= ========= ========
We also adopted SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," on January 1, 2002. SFAS No. 144, among other things,
modifies and updates the methodology for recognizing impairment in long-lived
assets. The adoption of this standard did not have a significant impact on
either the balance sheet or the statement of operations.
-6-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 1-Basis of Presentation - Cont'd.
- --------------------------------------------------------------------------------
Intangible assets subject to amortization, consisting of customer lists were
$2,644,000 and $0 at September 30, 2002 and December 31, 2001 (net of
accumulated amortization of $176,000 and $0, respectively). Intangible assets
not subject to amortization are as follows:
(amounts in thousands)
----------------------------------------
September 30, 2002 December 31, 2001
----------------------------------------
Goodwill ............... $22,905 $8,807(1)
Trademarks ............. $ 1,190 $ 0
(1) Amortization of goodwill ceased with the adoption of SFAS
No. 142 on January 1, 2002.
For the three and nine months ended September 30, 2002, the Company recorded
amortization expense of $88,000 and $176,000, respectively. For the three and
nine months ended September 30, 2001, the Company recorded amortization expense
of $189,000 and $553,000, respectively.
The estimated amortization expense for each of the five succeeding years and
thereafter is as follows:
For the Year Ended December 31,
-------------------------------
2002 ................................... $ 88(A)
2003 ................................... 353
2004 ................................... 353
2005 ................................... 353
2006 ................................... 353
2007 and thereafter .................... 1,144
(A) Represents estimated amortization expense for the
three months ending December 31, 2002.
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. We generally obtain oral or written purchase authorizations from our
customers for a specified amount of product at a specified price. Because we
either (i) have a general practice of covering customer losses while products
are in transit despite title transferring to the customer at the point of
shipment or (ii) have FOB - destination specifically set out in our arrangements
with federal agencies, delivery is deemed to have occurred at the point in time
when the product is received by the customer.
We provide our customers with a limited thirty day right of return generally
limited to defective merchandise. Revenue is recognized at delivery and a
reserve for sales returns is recorded. Management 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 estimable, we believe that the
impact on our financials would not necessarily be significant since the return
privilege expires 30 days after shipment.
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."
Accounts Receivable
We perform ongoing credit evaluations of our customers, and adjust credit limits
as appropriate, based on payment history and customer creditworthiness. We
maintain an allowance for estimated doubtful accounts based on our historical
experience and the customer credit issues identified. Collections are monitored
continuously, and the allowance is adjusted as necessary to recognize any
changes in credit exposure.
-7-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 1-Basis of Presentation - Cont'd.
- --------------------------------------------------------------------------------
We enter into contracts with the Federal Government requiring fees to be paid on
certain sales. These fees are subject to audit by the Federal Government. As a
result of these audits, we may be required to pay additional fees.
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 on management's forecast of customer
demand for those products in inventory.
Restricted - Cash
In connection with the acquisition of MoreDirect, Inc. (see Note 7 - Acquisition
of MoreDirect, Inc.), a $10 million cash escrow was established to fund a
portion of the contingent consideration.
Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make use of
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reported periods. We base our estimates on historical experience and
on various other assumptions that we believe are reasonable under the
circumstances, the results of which form the basis for making judgments about
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from those estimates, and revisions
to estimates are included in our results for the period in which the actual
amounts become known.
- --------------------------------------------------------------------------------
Note 2-Earnings Per Share
- --------------------------------------------------------------------------------
Basic earnings per common share is computed using the weighted average number of
shares outstanding. Diluted earnings per common share is computed using the
weighted average number of shares outstanding adjusted for the incremental
shares attributed to options outstanding to purchase common stock, if dilutive.
The following table sets forth the computation of basic and diluted earnings per
share:
- --------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended Ended
- --------------------------------------------------------------------------------------------------------------------------
September 30, (amounts in thousands, except per share data) 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Numerator:
Net income $ 2,206 $ 2,052 $ 383 $ 5,934
======== ======= ======== =========
Denominator:
Denominator for basic earnings per share:
Weighted average shares 24,533 24,506 24,546 24,449
Dilutive effect of unexercised
employee stock options: 256 415 302 503
-------- ------- -------- ---------
Denominator for diluted earnings per share 24,789 24,921 24,848 24,952
======== ======= ======== =========
Earnings per share:
Basic $ .09 $ .08 $ .02 $ .24
======== ======= ======== =========
Diluted $ .09 $ .08 $ .02 $ .24
======== ======= ======== =========
-8-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 2-Earnings Per Share - Cont'd.
- --------------------------------------------------------------------------------
The following unexercised stock options were excluded from the computation of
diluted earnings per share for the three and nine months ended September 30,
2002 and 2001 because the exercise prices of these options were generally
greater than the average market price of common shares during the respective
periods:
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- -------------------------------------------------------------------------------------------------------------------
September 30, (amounts in thousands) 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------
Anti-dilutive stock options 2,485 2,036 2,479 826
====== ======= ======= ======
- --------------------------------------------------------------------------------
Note 3-Reporting Comprehensive Income
- --------------------------------------------------------------------------------
We have no other comprehensive income in any of the periods presented.
Accordingly, a separate statement of comprehensive income is not presented.
- --------------------------------------------------------------------------------
Note 4-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.
In January 2002 we reorganized our operations to create two reportable operating
segments - the "Public Sector" segment, which serves federal, state and local
governmental organizations and educational institutions, and the "SMB" segment,
which serves small and medium-sized businesses, as well as consumers. In April
2002, we acquired MoreDirect, Inc. - the "Large Corporate Accounts" segment,
which serves medium-to-large corporations.
Segment information applicable to our reportable operating segments for the
three and nine months ended September 30, 2002 is shown below:
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2002
- -----------------------------------------------------------------------------------------------------------------------
SMB Public Sector Large Corp.
(amounts in thousands) Segment Segment Accts. Segment Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Sales to external customers $ 174,478 $ 96,265 $ 70,296 $ - $ 341,039
Transfers between segments 68,325 - - (68,325) -
----------- ----------- ------------ ------------ -----------
Net sales $ 242,803 $ 96,265 $ 70,296 $ (68,325) $ 341,039
=========== =========== ============ ============ ===========
Operating income (loss) $ 1,228 $ (1,363) $ 3,962 $ - $ 3,827
Interest and other - net (196) (13) 6 - (203)
----------- ----------- ------------ ------------ -----------
Income (loss) before taxes $ 1,032 $ (1,376) $ 3,968 $ - $ 3,624
=========== =========== ============ ============ ===========
- -----------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002
- -----------------------------------------------------------------------------------------------------------------------
SMB Public Sector Large Corp.
(amounts in thousands) Segment Segment Accts. Segment Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Sales to external customers $ 535,756 $ 209,446 $ 124,145 $ - $ 869,347
Transfers between segments 151,072 - - (151,072) -
----------- ----------- ------------ ------------ -----------
Net sales $ 686,828 $ 209,446 $ 124,145 $ (151,072) $ 869,347
=========== =========== ============ ============ ===========
Operating income (loss) $ (1,064) $ (4,221) $ 6,381 $ - $ 1,096
Interest and other - net (451) 8 29 - (414)
----------- ----------- ------------ ------------ -----------
Income (loss) before taxes $ (1,515) $ (4,213) $ 6,410 $ - $ 682
=========== =========== ============ ============ ===========
Total assets $ 179,478 $ 86,048 $ 67,170 $ (50,126) $ 282,570
=========== =========== ============ ============ ===========
Goodwill, net $ 1,173 $ 7,635 $ 14,097 $ - $ 22,905
=========== =========== ============ ============ ===========
- -----------------------------------------------------------------------------------------------------------------------
-9-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 4-Segment and Related Disclosures - Cont'd.
- --------------------------------------------------------------------------------
General and administrative expenses were charged to the reportable operating
segments, based on their estimated usage of the underlying functions. Interest
and other expense was charged to the segments, based on the actual costs
incurred by each segment, net of interest and other income generated. The amount
shown above representing total assets eliminated consists of inter-segment
receivables, resulting primarily from inter-segment sales and transfers reported
above and from inter-segment service charges.
In 2001 we had only one reportable operating segment. It is impractical for us
to restate prior year balances into the operating segments established in 2002.
Senior management monitored revenue in 2001 and 2002 by sales channel (Corporate
Outbound, Inbound Telesales and Online Internet) and product mix (Notebooks,
Desktops and Servers, Storage Devices, Software, Networking Communications,
Printers, Video and Monitors, Memory and Accessories and Other).
Net sales by sales channel and product mix are presented below:
-----------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
-----------------------------------------------------------------------------------------------------
September 30, (amounts in thousands) 2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------
Sales Channel
-------------
Corporate Outbound $ 272,755 $ 257,748 $ 678,153 $ 724,971
Inbound Telesales 16,348 31,897 67,690 109,648
On-Line Internet 51,936 23,240 123,504 77,962
---------- ---------- ---------- ----------
Total $ 341,039 $ 312,885 $ 869,347 $ 912,581
========== ========== ========== ==========
Product Mix
-----------
Notebooks $ 54,726 $ 70,484 $ 138,138 $ 200,223
Desktop/Servers 50,640 37,560 128,222 114,176
Storage Devices 30,706 28,673 83,145 87,871
Software 53,906 43,300 128,088 119,837
Networking Communications 27,757 29,389 72,960 84,036
Printers 29,262 26,143 76,901 76,233
Videos & Monitors 33,587 27,127 84,069 80,967
Memory 11,782 7,784 29,499 27,078
Accessories/Other 48,673 42,425 128,325 122,160
---------- ---------- ---------- ----------
Total $ 341,039 $ 312,885 $ 869,347 $ 912,581
========== ========== ========== ==========
Included in the above product mix sales are enterprise networking product sales
of $75.0 million and $58.9 million for the three months ended September 30, 2002
and 2001, respectively, and $191.8 million and $173.0 million for the nine
months ended September 30, 2002 and 2001, respectively.
Substantially all of our net sales for the quarters ended September 30, 2002 and
2001 were made to customers located in the United States. Shipments to customers
located in foreign countries aggregated less than 2% in those respective
quarters. All of our assets at September 30, 2002 and December 31, 2001 were
located in the United States. Except for the federal government, no single
customer accounted for more than 4% of total net sales in the nine months ended
September 30, 2002 and 2001. Sales to the federal government accounted for
$101.6 million, or 11.7% of total net sales for the nine months ended September
30, 2002, and $104.7 million, or 11.5% of total net sales for the nine months
ended September 30, 2001.
-10-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 5 - Credit Facility
- --------------------------------------------------------------------------------
In May 2002, we entered into a new $45 million credit facility that is secured
by substantially all of our business assets. In July 2002, as required under the
terms of the credit facility, an additional lender committed to fund $10.0
million of the $45 million facility. Amounts outstanding under this facility
bear interest at the prime rate (4.75% at September 30, 2002). The credit
facility includes various customary financial and operating covenants, minimum
net worth and maximum funded debt ratio requirements including restrictions on
the payment of dividends, none of which we believe significantly restricts our
operations. No borrowings were outstanding under this credit facility at
September 30, 2002. The credit facility matures on June 30, 2004, at which time
amounts outstanding become due.
- --------------------------------------------------------------------------------
Note 6 - Restructuring Costs and Other Special Charges
- --------------------------------------------------------------------------------
On March 15, 2002, we announced that we had settled litigation commenced by
Microsoft Corporation involving alleged trademark and copyright infringement.
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 were
included as a special charge in our first quarter 2002 financial results. We
incurred charges of $718,000 and $886,000 for the three and nine month periods
ending September 30, 2002 related to staff reductions during each of the
respective periods.
A rollforward of restructuring costs and other special charges for the nine
months ended September 30, 2002 is shown below:
-------------------------------------------------------------------------------------------------------------------
Beginning Liabilities at
(amounts in thousands) Balance Total Charges Cash Payments September 30, 2002
-------------------------------------------------------------------------------------------------------------------
Settlement of Microsoft litigation charges $ - $ 750 $ (750) $ -
Workforce reduction 425 886 (827) 484
---------- ---------- --------- ----------
Total $ 425 $ 1,636 $ (1,577) $ 484
========== ========== ========= ==========
- --------------------------------------------------------------------------------
Note 7 - Acquisition of MoreDirect, Inc.
- --------------------------------------------------------------------------------
On April 5, 2002, we completed the acquisition of MoreDirect, Inc. (MoreDirect)
and it became a wholly-owned subsidiary of PC Connection, Inc. The acquisition
of MoreDirect provides PC Connection a premier e-procurement supplier of
information technology (IT) products for medium-to-large corporate and
government organizations nationwide. MoreDirect's Internet-based system enables
corporate and government customers to efficiently source, evaluate, purchase and
track a wide variety of IT products.
Under the terms of the agreement, all outstanding stock options of MoreDirect
were cashed out for approximately $4.1 million, which was funded by us, and we
paid the sole shareholder of MoreDirect approximately $18.0 million in cash at
closing. MoreDirect also distributed approximately $7.9 million to its sole
shareholder from available cash balances for previously taxed but undistributed
S Corporation earnings. In addition we will pay additional cash to the
MoreDirect shareholder based upon MoreDirect achieving targeted levels of annual
earnings before income taxes through December 31, 2004. We also escrowed $10.0
million in cash at closing to fund a portion of these contingent payments.
Acquisition costs of $0.6 million have been included in the purchase price.
The transaction was accounted for by the purchase method, and accordingly,
MoreDirect's results of operations are included in our consolidated financial
statements only for periods after April 5, 2002.
-11-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 1 - Financial Statements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
(Unaudited)
- --------------------------------------------------------------------------------
Note 7 - Acquisition of MoreDirect, Inc. - Cont'd.
- --------------------------------------------------------------------------------
The following table summarizes the fair values of the assets acquired and
liabilities assumed at the date of the acquisition. The fair values of certain
intangible assets were determined through a third party valuation. The current
purchase price allocation is preliminary, and is subject to further adjustment
and review.
---------------------------------------------------------------------------------
At April 5, 2002 (amounts in thousands)
---------------------------------------------------------------------------------
Current assets ..................................................... $ 29,675
Property, plant and equipment and other assets ..................... 197
Intangible assets .................................................. 5,400
Goodwill ........................................................... 14,097
---------
Total acquired ............................................... 49,369
Current liabilities ................................................ 26,669
---------
Net assets acquired ................................................ 22,700
Less cash acquired ................................................. 115
---------
Purchase price for acquisition, net of cash acquired ............... $ 22,585
=========
Of the $5.4 million of acquired intangible assets, $1.2 million was assigned to
registered trademarks that are not subject to amortization. The remaining $4.2
million of acquired intangible assets include software/technology of $1.4
million (5 year weighted-average useful life) and $2.8 million of customer
relationships (8 year weighted-average useful life).
The following unaudited pro forma information presents the results of our
operations as if the acquisition of MoreDirect had taken place as of the
beginning of the periods presented:
------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended Ended
------------------------------------------------------------------------------------------------------------------------
September 30, (amounts in thousands, except per share data) 2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------------
Net revenue $ 341,039 $ 372,416 $ 923,857 $ 1,080,904
Net income 2,206 3,944 2,043 10,548
Earnings per share:
Basic $ .09 $ .16 $ .08 $ .43
========== ========== ========== ===========
Diluted $ .09 $ .16 $ .08 $ .42
========== ========== ========== ===========
- --------------------------------------------------------------------------------
Note 8 - Recently Issued Accounting Pronouncements
- --------------------------------------------------------------------------------
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146
"Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and replaces Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." It requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred, rather than
at the date of a commitment to an exit or disposal plan. The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with earlier application encouraged. The restructuring
activities undertaken by us prior to the issuance of this statement have been
appropriately accounted for under EITF 94-3. (See Note 6.)
-12-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Overview
- --------------------------------------------------------------------------------
The Management's Discussion and Analysis of Financial Condition and Results of
Operations presented below reflects the restatement to previously issued
consolidated financial statements for the three and nine month periods ending
September 30, 2001.
Recently our management determined that a change in our revenue recognition
policy for sales of product should have been made as of January 1, 1999 in order
to comply with Staff Accounting Bulletin No. 101 "Revenue Recognition in
Financial Statements" ("SAB101"). Despite title passing upon shipment to the
customer, our general practice has been to cover customer losses that were
incurred while the products were in transit. SAB101, as interpreted by the SEC
staff, would dictate that it is inappropriate to record revenue until delivery
because our actions have created a "de facto" title passage at the time of
delivery. Therefore, management has concluded that revenue should, and will, be
recorded at the time of delivery rather than at the time of shipment.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that are subject to
risks and uncertainties, including, but not limited to, the impact of changes in
market demand and the overall level of economic activity, or in the level of
business investment in information technology products, competitive products and
pricing, product availability and market acceptance, new products, fluctuations
in operating results and other risks detailed under the caption, "Factors That
May Affect Future Results and Financial Condition" set forth below. 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," "expect," 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. More specifically, the statements
in this report concerning our outlook for the balance of 2002 and the statements
concerning our gross margin percentage and selling and administrative costs and
other statements of a non-historical basis (including statements regarding
implementing strategies for future growth, our ability to regain our model of
profitable growth and the expected benefits of our electronic commerce strategy)
are forward-looking statements that involve certain risks and uncertainties.
Such risks and uncertainties include the ability to realize market demand for
and competitive pricing pressures on the products and services marketed by us,
the continued acceptance of our distribution channel by vendors and customers,
continuation of key vendor relationships and support programs and our ability to
hire and retain qualified sales account managers and other essential personnel.
Except as required by law, we undertake 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 we file from time to time with the SEC.
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------------------------
We were founded in 1982 as a mail-order business offering a broad range of
software and accessories for IBM and IBM-compatible personal computers ("PCs").
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 seek to generate sales through
(i) outbound telemarketing by account managers focused on the business,
education and government markets, (ii) inbound calls from customers responding
to 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 four years, from 19.4% of net
sales for the year ended December 31, 1998 to 8.6% of net sales for the nine
months ended September 30, 2002. We believe that sales attributable to Mac
products will continue to decrease as a percentage of net sales and may decline
in absolute dollar volume in 2002 and future years.
The weakness in demand for information technology products experienced by us in
2001 continued through the third quarter of 2002 resulting in overall
conservative buying patterns, order deferrals and longer sales cycles.
- --------------------------------------------------------------------------------
Critical Accounting Policies
- --------------------------------------------------------------------------------
In our December 31, 2001 Form 10-K/A, under the caption "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and in
the Notes to the Consolidated Financial Statements, we disclosed what we
consider to be our critical accounting policies. We applied those same
accounting policies in the preparation of the accompanying condensed
consolidated financial statements, except for the adoption on January 1, 2002 of
SFAS Nos. 142 and 144 and the corresponding cessation of goodwill amortization.
SFAS No. 142 required, among other things, the discontinuance of the
amortization of goodwill and certain other identified intangibles. It also
required a January 1, 2002 reassessment of the recover- ability of the goodwill
that was carried on our financial statements. We have ceased amortization of
goodwill in 2002. SFAS No. 142 also 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
have completed the initial impairment review required by SFAS No, 142 and have
determined that our goodwill and intangible assets were not impaired.
-13-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Critical Accounting Policies - Cont'd.
- --------------------------------------------------------------------------------
We also adopted SFAS No. 144, which among other things, modifies and updates the
methodology for recognizing impairment in long-lived assets. The adoption of
this standard did not have a significant impact on either the balance sheet or
the statement of income.
- --------------------------------------------------------------------------------
Results of Operations
- --------------------------------------------------------------------------------
Three Months and Nine Months Ended September 30, 2002 Compared with the Three
Months and Nine Months Ended September 30, 2001.
The following table sets forth for the periods indicated information derived
from our statements of operations expressed as a percentage of net sales.
------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
------------------------------------------------------------------------------------------------------------------
September 30, 2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------
Net sales (in millions) ............................ $ 341.0 $ 312.9 $ 869.3 $ 912.6
======= ======== ======= ========
Net sales .......................................... 100.0% 100.0% 100.0% 100.0%
Gross profit ....................................... 10.9 10.7 10.7 11.1
Selling, general and administrative expenses ....... 9.6 9.3 10.4 9.9
Restructuring costs and other special charges ...... 0.2 0.4 0.2 0.2
Income from operations ............................. 1.1 1.0 0.1 1.0
The following table sets forth our percentage of net sales by sales channel and
product mix:
------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
------------------------------------------------------------------------------------------------------------------
September 30, 2002 2001 2002 2001
------------------------------------------------------------------------------------------------------------------
Sales Channel
-------------
Corporate Outbound ................................. 80% 82% 78% 79%
Inbound Telesales .................................. 5 10 8 12
On-Line Internet ................................... 15 8 14 9
---- ----- ---- ----
Total ............................................ 100% 100% 100% 100%
==== ===== ==== ====
Product Mix
-----------
Notebooks .......................................... 16% 23% 16% 22%
Desktop/Servers .................................... 15 12 15 13
Storage Devices .................................... 9 9 10 10
Software ........................................... 16 14 15 13
Networking Communications .......................... 8 9 8 9
Printers ........................................... 9 8 9 8
Videos & Monitors .................................. 10 9 10 9
Memory ............................................. 3 2 3 3
Accessories/Other .................................. 14 14 14 13
---- ----- ---- ----
Total ............................................ 100% 100% 100% 100%
==== ===== ==== ====
For the three months ended September 30, 2002, sales of enterprise server
and networking products (included in the above product mix) were 22% of
net sales, compared to 19% of net sales for the comparable period in 2001.
Sales of enterprise server and networking products (included in the above
product mix) were 22% and 19% of net sales for the nine months ended
September 30, 2002 and September 30, 2001, respectively.
-14-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Results of Operations - Cont'd.
- --------------------------------------------------------------------------------
Three Month Period Ended September 30, 2002 Compared to Three Month Period Ended
September 30, 2002
Net sales increased $28.1 million, or 9.0%, to $341.0 million for the three
months ended September 30, 2002 from $312.9 million for the three months ended
September 30, 2001 due to our acquisition of MoreDirect in early April 2002.
Outbound channel sales increased 5.8% to $272.8 million for the quarter ended
September 30, 2002 over the comparable 2001 quarter. On-line Internet sales
increased 123.5% to $51.9 million for the quarter ended September 30, 2002
compared to the comparable period in 2001. Inbound channel sales, which
primarily serve our consumer and very small business customers, decreased 48.8%,
to $16.3 million for the quarter ended September 30, 2002, compared to the
comparable period in 2001.
Excluding sales for MoreDirect, net sales for the three months ended September
30, 2002 decreased $42.2 million, or 13.5%, to $270.7 million from net sales of
$312.9 million for the comparable period in 2001. On this basis, outbound
channel net sales decreased by 12.3% for the quarter ended September 30, 2002
compared to the comparable period in 2001, and on-line Internet sales increased
21.7% to $28.3 million for the quarter ended September 30, 2002 compared to the
comparable period in 2001.
Sequentially, net sales increased $49.8 million, or 17.1%, to $341.0 million for
the three months ended September 30, 2002 from $291.2 million for the three
months ended June 30, 2002. Net sales for our Public Sector segment, which sells
to federal, state and local government organizations and educational
institutions, increased sequentially by 51.2% to $96.3 million for the three
months ended September 30, 2002 compared to the three months ended June 30,
2002. As we have experienced in prior years, federal government purchases in the
third quarter were up significantly from the second quarter. Net sales for the
small - and medium-sized business (SMB) segment were $174.5 million, virtually
level with net sales of $173.6 million for the three months ended June 30, 2002.
Third quarter 2002 net sales for MoreDirect, which comprises our Large Corporate
Accounts segment, increased by 30.7% to $70.3 million compared to the three
months ended June 30, 2002 as large commercial customers continue to respond
favorably to MoreDirect's efficient e-procurement model.
Net sales of enterprise server and networking products increased 27.3% to $75.0
million for the quarter ended September 30, 2002 from $58.9 million for the
comparable period in 2001. Enterprise server and networking products represented
22.0% of overall net sales for the third quarter in 2002, up from 18.8% of net
sales for the comparable period in 2001. We believe that these product
categories will continue to grow as our customers further upgrade their network
and communication infrastructure. If economic conditions do not improve in the
near term, the anticipated sales growth of these types of products will not
likely occur. Sales of notebooks declined by 22.4% to $54.7 million for the
quarter ended September 30, 2002, from the comparable period in 2001.
Desktop/server sales increased by 34.6% to $50.6 million for the quarter ended
September 30, 2002 over the comparable period in 2001.
Software sales increased 24.5% to $53.9 million for the quarter ended September
30, 2002 from $43.3 million for the comparable period in 2001 partly due to the
acceleration in 2002 sales attributed to the July 31 deadline for Microsoft's
upgrade programs.
Average order size increased $64, or 5.1%, to $1,323 for the quarter ended
September 30, 2002 compared to the third quarter of 2001 partly due to the
MoreDirect acquisition. In addition, average order size increased sequentially
by 17.4% in the third quarter from the second quarter of 2002. The total number
of orders received for the quarter increased by 3.1% over the second quarter of
2002 compared to the 17.1% quarter-over-quarter increase in total net sales
dollars. The total number of orders increased by 5.8% year-over-year, compared
to the 9.0% year-over-year increase in total net sales dollars. Average
annualized sales productivity per account manager for the quarter improved
sequentially by 9.5% to $2.3 million compared to $2.1 million in the second
quarter of 2002.
Gross profit increased $3.7 million, or 11.0%, to $37.2 million for the quarter
ended September 30, 2002 from $33.5 million for the comparable period in 2001,
primarily due to the increase in sales described above. Gross profit margin as a
percentage of sales increased to 10.9% of net sales in the third quarter of 2002
from 10.7% for the comparable period in 2001 and improved sequentially by 0.1%
from 10.8% for the quarter ended June 30, 2002. MoreDirect's gross profit margin
for the three months ended September 30, 2002 increased to 10.8% from 10.4% for
the second quarter 2002. Gross profit margins in our small- and medium-sized
business segment improved by 0.7% over the quarter ended June 30, 2002 to 12.3%
for the quarter ended September 30, 2002, primarily due to the improved
attainment of vendor incentive rebates. Gross profit margins in our public
sector segment decreased by 0.4% from the quarter ended June 30, 2002 to 8.4%
for the quarter ended September 30, 2002.
-15-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Results of Operations - Cont'd.
- --------------------------------------------------------------------------------
Our gross profit margins are also influenced by the relative mix of sales to
commercial, government, education and consumer customers and by the relative mix
of inbound, outbound and on-line Internet sales. Since outbound sales are
typically to corporate and government accounts that purchase at volume
discounts, the gross profit margin percentage of such sales is generally lower
than inbound sales. However, the gross profit dollar contribution per outbound
sales order is generally higher as average order sizes are usually larger. We
expect that our gross profit margin, as a percentage of sales, may vary by
quarter based upon vendor support programs, product mix, pricing strategies,
market conditions and other factors.
Selling, general and administrative expenses increased $3.5 million, or 12.0% to
$32.6 million for the quarter ended September 30, 2002 from $29.1 million for
the third quarter in 2001, partly due to our acquisition of MoreDirect in April
2002. SG&A as a percentage of net sales were 9.6% in the third quarter of 2002,
compared to 9.3% in the comparable period a year ago and 10.5% in the second
quarter of 2002. Increases in our net advertising expense were partly offset by
decreases in volume sensitive costs, such as bad debt expense and credit card
fees. We expect that our 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 our Internet Web technology to support the sales
organization. SG&A in the third quarter of 2001 included goodwill amortization
of $176 thousand. There were no such charges in the corresponding 2002 quarter.
Had the $176 thousand not been amortized in the third quarter of 2001, earnings
per share would not have been significantly affected.
Restructuring costs and other special charges totaling $0.7 million were
recorded in the third quarter of 2002. These charges were related to workforce
reductions. Restructuring costs or other special charges totaled $1.2 million
for the comparable period in 2001. These costs related to staff reductions of
$0.5 million and $0.7 million of costs associated with proposed acquisitions
abandoned during the third quarter of 2001.
Income from operations increased $0.6 million, or 18.8%, to $3.8 million for the
quarter ended September 30, 2002, from $3.2 million for the comparable period in
2001. Income from operations as a percentage of sales increased from 1.0% in the
three months ended September 30, 2001 to 1.1% for the comparable period in 2002
for the reasons discussed above.
Income (loss) from operations for the quarter ended September 30, 2002,
excluding the acquisition of MoreDirect, was a loss of $0.1 million. Our Public
Sector segment (as described in Note 4 to our Condensed Consolidated Financial
Statements) incurred an operating loss of $1.3 million, and our SMB segment
earned $1.2 million of operating income.
Interest expense remained flat at $0.3 million for the quarters ended September
30, 2002 and 2001.
Other, net which is essentially comprised of interest income decreased $0.3
million, or 75.0%, to $0.1 million for the quarter ended September 30, 2002 from
$0.4 million for the comparable period in 2001 due to lower interest rates and
lower investment levels.
Income taxes for the quarter ended September 30, 2002 were $1.4 million compared
to $1.3 million for the comparable quarter in 2001. The effective tax rate was
39.1% for the three months ended September 30, 2002 and 38.0% for the three
months ended September 30, 2001. The increase was due to the impact on our state
tax rate from the acquisition of More Direct.
Net income for the quarter ended September 30, 2002 increased $0.1 million, or
4.8%, to $2.2 million from net income of $2.1 million for the comparable quarter
in 2001, as a result of the increase in income from operations.
-16-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Results of Operations - Cont'd.
- --------------------------------------------------------------------------------
Nine Month Period Ended September 30, 2002 Compared to Nine Month Period Ended
September 30, 2001
Net sales decreased $43.3 million, or 4.7%, to $869.3 million for the nine
months ended September 30, 2002 from $912.6 million for the comparable period in
2001 due to the continued weakness in demand for information technology
products. Outbound channel sales decreased 6.5% to $678.2 million for the nine
months ended September 30, 2002 over the comparable 2001 period. On-line
Internet sales increased 58.4% to $123.5 million for the nine months ended
September 30, 2002 compared to the corresponding prior year period in 2001.
Inbound channel sales, which primarily serve our consumer and very small
business customers, decreased 38.2%, to $67.7 million for the nine months ended
September 30, 2002, compared to $109.6 million for the corresponding period in
2001. Excluding sales for MoreDirect, net sales for the nine months ended
September 30, 2002 decreased $167.4 million, or 18.3%, to $745.2 million from
$912.6 million for the comparable period in 2001. Excluding on-line Internet
sales for MoreDirect, on-line Internet sales increased 7.8% to $84.1 million for
the nine months ended September 30, 2002, compared to the nine months ended
September 30, 2001.
Net sales for our Public Sector segment, which sells to the federal, state and
local government organizations and educational institutions, increased 3.7% to
$209.4 million for the nine months ended September 30, 2002 from $202.0 million
for the nine months ended September 30, 2001. Net sales for the small - and
medium business (SMB) segment for the nine months ended September 30, 2002 were
$535.8 million, a decrease of $174.7 million, or 24.6%, from net sales of $710.5
million for the SMB segment in the same period of 2001. MoreDirect, our large
corporate account segment, has generated net sales of $124.1 million since our
acquisition in April 2002 through September 30, 2002.
Net sales of enterprise server and networking products increased 10.9% to $191.8
million for the nine months ended September 30, 2002 from $173.0 million for the
comparable period in 2001. While we believe that these product categories will
continue to grow as our customers further upgrade their network and
communication infrastructure, if economic conditions do not improve in the near
term, the level of sales growth will be limited. Enterprise server and
networking products represented 22.1% of overall net sales for the nine months
ended September 30, 2002, up from 19.0% of net sales for the comparable period
in 2001. Sales of notebooks declined by 31.0% to $138.1 million for the nine
months ended September 30, 2002, from $200.2 million for the comparable period
in 2001. Desktop/server sales increased by 12.3% to $128.2 million for the nine
months ended September 30, 2002, from $114.2 million for the comparable period
in 2001.
Gross profit for the nine months ended September 30, 2002 decreased $8.3
million, or 8.2%, to $93.4 million from $101.7 million for the comparable period
in 2001. Gross profit margin as a percentage of net sales also decreased to
10.7% in the first nine months of 2002 from 11.1% for the comparable period in
2001.
A more competitive pricing environment and lower overall demand during the first
nine months of 2002 negatively impacted our year-over-year gross margin
percentages. Our gross profit margins are also influenced by the relative mix of
sales to commercial, government, education and consumer customers and by the
relative mix of inbound, outbound and on-line Internet sales. Since outbound
sales are typically to corporate and government accounts that purchase at volume
discounts, the gross profit margin percentage of such sales is generally lower
than inbound sales. However, the gross profit dollar contribution per outbound
sales order is generally higher as average order sizes are usually larger. We
expect that our gross profit margin, as a percentage of sales, may vary by
quarter based upon vendor support programs, product mix, pricing strategies,
market conditions and other factors.
Selling, general and administrative expenses increased $0.5 million, or 0.6%, to
$90.7 million for the nine months ended September 30, 2002 over the comparable
period in 2001. SG&A as a percentage of net sales increased to 10.4% in 2002
compared to 9.9% for the comparable period in 2001. Increases related to our Web
site initiatives were offset by decreases in volume sensitive costs, such as
variable compensation and credit card fees. We expect that our 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 our
Internet Web technology to support the sales organization. SG&A in each of the
first three quarters of 2001 included goodwill amortization of $176 thousand.
There were no such charges in the corresponding 2002 quarters. Had the $176
thousand not been amortized in each of the first three quarters of 2001,
earnings per share would not have been significantly affected.
-17-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Results of Operations - Cont'd.
- --------------------------------------------------------------------------------
Restructuring costs and other special charges for the nine-month periods ended
September 30, 2002 and 2001, totaled $1.6 million and $2.1 million,
respectively. On March 15, 2002, we announced that we had settled litigation
commenced by Microsoft Corporation involving alleged trademark and copyright
infringement. While denying these allegations, we recorded $0.8 million in
settlement costs and legal fees related to this matter. We also took $0.9
million and $1.4 million charges related to staff reductions for the nine months
ended September 30, 2002 and 2001, respectively.
A rollforward of restructuring costs and other special charges for the nine
months ended September 30, 2002, is shown below:
- -----------------------------------------------------------------------------------------------------------------------------------
Beginning Liabilities at
(amounts in thousands) Balance Total Charges Cash Payments September 30, 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Settlement of Microsoft litigation charges $ - $ 750 $ (750) $ -
Workforce reduction 425 886 (827) 484
---------- ---------- --------- ----------
Total $ 425 $ 1,636 $ (1,577) $ 484
========== ========== ========= ==========
Income from operations decreased $8.3 million, or 88.3%, to $1.1 million for the
nine months ended September 30, 2002, compared to income of $9.4 million for the
comparable period in 2001. As a percentage of net sales, income from operations
decreased from 1.0% for the nine months ended September 30, 2001 to 0.1% for the
nine months ended September 30, 2002.
Interest expense decreased $0.1 million, or 11.1% to $0.8 million for the nine
months ending September 30, 2002 from $0.9 million for the comparable period in
2001. This decrease in interest expense was attributed to lower average
borrowings during the first nine months of 2002 as compared to the comparable
period in 2001.
Other, net which is essentially comprised of interest income decreased $0.6
million, or 60.0%, to $0.4 million for the nine months ended September 30, 2002,
from $1.0 million for the comparable period in 2001, attributable to lower
interest rates and lower investment levels.
Income taxes for the nine months ended September 30, 2002, were $0.3 million
compared to $3.6 million for the comparable period in 2001, consistent with the
decrease in income from operations.
Net income decreased $5.5 million, or 93.2%, to $0.4 million for the nine months
ended September 30, 2002 from $5.9 million for the comparable 2001 period for
the reasons described above.
- --------------------------------------------------------------------------------
Seasonality
- --------------------------------------------------------------------------------
Although we have historically experienced variability in the rates of sales
growth, we have not historically experienced seasonality in our business as a
whole. While sales in our Large Corporate Accounts and SMB segments, which
serve business and consumer markets, have not historically experienced
significant seasonality throughout the year, sales in our public sector segment
have historically been higher in the third quarter than in other quarters due to
the buying patterns of government and education customers. If sales to public
sector customers continue to increase as a percentage of overall sales, the
Company as a whole may experience increased seasonality in future periods.
- --------------------------------------------------------------------------------
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 through the next twelve months. Our ability to continue
funding our planned growth 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 reduced.
-18-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Liquidity and Capital Resources - Cont'd.
- --------------------------------------------------------------------------------
At September 30, 2002, we had cash and cash equivalents of $13.9 million and
working capital of $92.5 million. At December 31, 2001, we had cash and cash
equivalents of $35.6 million and working capital of $120.4 million. This
decrease in cash and cash equivalents is attributable to the approximate $22.6
million in cash used for the acquisition of MoreDirect.
In May 2002, we entered into a $45 million credit facility secured by
substantially all of our business assets. In July 2002, as required under the
terms of the credit facility, an additional lender committed to fund $10.0
million of the $45 million facility. Amounts outstanding under this facility
bear interest at the prime rate (4.75% at September 30, 2002). The credit
facility includes various customary financial and operating covenants, minimum
net worth and maximum funded debt ratio requirements, including restrictions on
the payment of dividends, none of which we believe significantly restricts our
operations. No borrowings were outstanding under this credit facility at
September 30, 2002. The credit facility matures on June 30, 2004, at which
time the amounts outstanding become due.
Net cash provided by operating activities was $16.7 million for the nine months
ended September 30, 2002, as compared to $52.0 million provided by operating
activities in the comparable period in 2001. The primary factors historically
affecting cash flows from operations are our net income and changes in the
levels of accounts receivable, inventories and accounts payable. In particular,
accounts receivable has increased by $35.5 million in the nine months ended
September 30, 2002, in part due to accounts receivable generated by MoreDirect.
At September 30, 2002, we had $142.6 million in outstanding net accounts
receivable. During the third quarter of 2002, days sales outstanding increased
sequentially by 2 days to 50 days at September 30, 2002 from 48 days at June 30,
2002.
Inventories totaled $52.8 million at September 30, 2002, compared to $43.8
million at June 30, 2002 and $57.5 million at December 31, 2001. During the
third quarter of 2002, inventory turns improved sequentially to 24 turns at
September 30, 2002 compared to 22 turns at June 30, 2002. Net sales of products
drop-shipped by distributors and other vendors directly to customers accounted
for 42.2% of net sales in the third quarter compared to 34.0% in the second
quarter of 2002.
At September 30, 2002, we had $111.1 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, if necessary, short-term borrowings
under the line of credit. This amount includes $6.6 million payable to two
financial institutions under security agreements to facilitate the purchase of
inventory.
Capital expenditures were $4.4 million in the nine months ended September 30,
2002 as compared to $4.9 million in the comparable period in 2001. The majority
of the capital expenditures for the respective 2002 and 2001 periods relate to
computer hardware and software purchases for our information systems. Total
capital expenditures for the year ending December 31, 2002 are estimated to be
$6.0 million.
We have disclosed significant related party transactions and our future
commitments in our Form 10-K/A. There have been no substantial changes in those
disclosures since year-end.
- --------------------------------------------------------------------------------
Recently Issued Accounting Pronouncements
- --------------------------------------------------------------------------------
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146
"Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and replaces Emerging Issues Task Force (EITF) Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." It requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred, rather than
at the date of a commitment to an exit or disposal plan. The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with earlier application encouraged. The restructuring
activities undertaken by us prior to the issuance of this statement have been
appropriately accounted for under EITF 94-3. (See Note 6).
- --------------------------------------------------------------------------------
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.
-19-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
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.
There has been a general decline in the economy over the past year and the
demand for personal computer products has decreased throughout the industry.
This decrease adversely affected our sales and results of operations in 2001,
and continues to adversely affect our sales and results of operations in 2002.
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
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
$1,440.2 million for the year ended December 31, 2000. In the year ended
December 31, 2001, our net sales declined to $1,186.2 million. Net sales for the
nine months ended September 30, 2002 declined by 4.7% from the comparable 2001
period, despite our acquisition of MoreDirect. 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 maintain our operating margins.
Moreover, we can provide no assurance that we will be able to sustain 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.
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. Lastly, sales in our public segment have historically
been higher in the third quarter than in other quarters due to the buying
patterns of government and education customers.
-20-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition - Cont'd.
- --------------------------------------------------------------------------------
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 may
in the future 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 71% and 60% of our total product purchases in
the nine-month periods ended September 30, 2002 and 2001, respectively. Among
these five vendors, purchases from Ingram Micro, Inc. represented 31% and 25% of
our total product purchases and purchases from Tech Data Corporation comprised
15% and 16% of our total product purchases in the nine-month periods ended
September 30, 2002 and 2001, respectively. Effective May 3, 2002, Compaq
Computer Corporation became a wholly-owned subsidiary of Hewlett Packard
Company. Had this merger been completed at the beginning of the periods
presented, our purchases made directly from Hewlett Packard, on a pro forma
basis, would have constituted 15% and 11% of our total product purchases in the
nine-month periods ended September 30, 2002 and 2001, respectively. No other
vendor supplied more than 7% of our total product purchases in the nine-month
periods ended September 30, 2002 and 2001. If we were unable to acquire products
from Ingram Micro, Tech Data or Hewlett Packard, 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 September 30, 2002 was $111.1
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.
-21-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition - Cont'd.
- --------------------------------------------------------------------------------
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 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, Hewlett-Packard and IBM,
currently sell some of their products directly to end users and have stated
their intentions to increase the level of such direct sales. In addition,
manufacturers may attempt to increase the volume of software products
distributed electronically to end users. An increase in the volume of products
sold through or used by consumers of any of these competitive programs or
distributed electronically to end users could have a material adverse effect on
our results of operations.
-22-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition - Cont'd.
- --------------------------------------------------------------------------------
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.
In 2001, we shipped 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.
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.
-23-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS-CONTINUED
- --------------------------------------------------------------------------------
Factors That May Affect Future Results and Financial Condition - Cont'd.
- --------------------------------------------------------------------------------
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.
Sales taxes are presently collected on sales of products by several of our sales
subsidiaries in as many as 25 states and the District of Columbia. 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. Moreover,
certain states have sought to impose state sales taxes on vendors who drop ship
goods. 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 our 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 or if states
impose state sales taxes on drop shipped goods, 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 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.
-24-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES 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
secured credit agreement provides for borrowings which bear interest based on
the prime rate. We had no borrowings outstanding pursuant to our credit
agreement as of September 30, 2002. 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.
-25-
PC CONNECTION, INC. AND SUBSIDIARIES
Part I - Financial Information
Item 4- CONTROLS AND PROCEDURES
1. Evaluation of disclosure controls and procedures. Based on their evaluation
of the Company's disclosure controls and procedures (as defined in Rules
13a - 14 (c) and 15d - 14(c) under the Securities Exchange Act of 1934) as
of a date within 90 days of the filing date of this Quarterly Report on
Form 10-Q, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and
procedures are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms and are operating in an effective
manner.
2. Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their most recent
evaluation.
-26-
PC CONNECTION, INC. AND SUBSIDIARIES
Part II - Other Information
Item 1 - Legal Proceedings
Not applicable.
Item 2 - Changes in Securities and Use of Proceeds
Not applicable.
Item 3 - Defaults Upon Senior Securities
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5 - Other Information
Not applicable.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
10.52 Separation Agreement between Registrant and Wayne
Wilson, dated September 19, 2002.
15 Letter on unaudited interim financial information.
99.1 Certification of the Company's Chief Executive
Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification of the Company's Senior Vice President
of Finance and Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
(I) The Company filed a Current Report on Form 8-K on
September 17, 2002, reporting that the Company was
planning to participate in various investor meetings and
will be discussing various aspects of its business.
(II) The Company filed a Current Report on Form 8-K on
September 20, 2002 announcing that Wayne Wilson,
President and Chief Operating Officer, would be retiring
from PCC at the end of September and Kenneth Koppel,
Chief Executive Officer, would assume title of President
and Patricia Gallup will resume title of Chief Executive
Officer.
-27-
PC CONNECTION, INC. AND SUBSIDIARIES
September 30, 2002
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PC CONNECTION, INC. AND SUBSIDIARIES
November 14, 2002 By: /s/ PATRICIA GALLUP
-------------------------------------
Patricia Gallup
Chairman and Chief Executive Officer
November 14, 2002 By: /s/ MARK GAVIN
-------------------------------------
Mark Gavin
Senior Vice President of Finance and
Chief Financial Officer
-28-
PC CONNECTION, INC. AND SUBSIDIARIES
September 30, 2002
Certification
I, Patricia Gallup, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PC Connection,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statement made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects, the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: November 14, 2002 /S/ PATRICIA GALLUP
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Patricia Gallup
Chairman and Chief Executive Officer
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I, Mark Gavin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PC Connection,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statement made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects, the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared.
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: November 14, 2002 /S/ MARK GAVIN
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Mark Gavin
Senior Vice President, Finance and
Chief Financial Officer
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