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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition period from _________ to _________.
Commission file number: 0-25790
CREATIVE COMPUTERS, INC.
Delaware 95-4518700
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2555 West 190th Street, Torrance, California 90504
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (310) 354-5600
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment this
Form 10-K. [ ]
As of March 28, 2000, the aggregate market value of the Common Stock held
by non-affiliates of the Registrant was approximately $77 million. The number
of shares outstanding of the Registrant's Common Stock as of March 28, 2000 was
10,409,726.
Documents incorporated by reference into Part III: Portions of the
definitive Proxy Statement for the Registrant's 2000 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.
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CREATIVE COMPUTERS, INC.
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business........................................................ 3
Item 2. Properties...................................................... 19
Item 3. Legal Proceedings............................................... 19
Item 4. Submission of Matters to a Vote of Security Holders............. 19
PART II
Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters............................................. 20
Item 6. Selected Financial Data......................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 22
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...... 27
Item 8. Financial Statements and Supplementary Data..................... 27
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.......................... 27
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 28
Item 11. Executive Compensation.......................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 28
Item 13. Certain Relationships and Related Transactions.................. 28
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 29
SIGNATURES.................................................................. 31
2
PART I
ITEM 1. BUSINESS
General
Creative Computers, Inc. (the "Company"), founded in 1987, is a direct
marketer of personal computer hardware, software, peripheral products and
consumer electronics. The Company offers products to individual consumers, home
offices, small businesses and large corporations through direct response
catalogs, dedicated inbound and outbound telemarketing sales executives, the
Internet, a direct sales force, and a retail showroom. The Company offers a
broad selection of products through its six worldwide web sites on the Internet,
ecost.com, pcmall.com, macmall.com, computability.com, ccit-inc.com and
elinux.com, and its distinctive full-color catalogs, including MacMall, PC Mall
Business Solutions, PC Mall.com, and ComputAbility and other promotional
materials. The Company's staff of knowledgeable telemarketing sales executives,
customer service and technical support personnel work together to serve
customers by assisting in product selection and offering technical assistance.
The Company believes that its high level of customer service results in customer
loyalty and repeat customer orders. The Company recently announced its plans to
intensify its focus on the Internet and business-to-business markets by
developing its growing portfolio of web site properties.
In 1997, the Company acquired and assimilated two marketers of personal
computer hardware and software products, Elek-Tek, Inc. (currently operating as
CCIT) and ComputAbility, Ltd. During 1997, the Company operated four retail
showrooms in Southern California under the name Creative Computers and three
retail showrooms in Illinois and one retail showroom in Indiana under the name
of Elek-Tek. In the first quarter of 1998, the Company closed all but one of its
showrooms to focus its efforts on its catalog, corporate and Internet channels.
Net sales from the Company's retail showroom operations were $67.8 million,
$43.6 million and $34.7 million for the years ended December 31, 1997, 1998 and
1999, representing 12.4%, 6.8% and 4.7% of net sales, respectively.
In September 1997, the Company formed a wholly-owned subsidiary, uBid, to
sell computer-related products and consumer electronics through an auction
format on the Internet. On December 9, 1998, uBid completed an initial public
offering of 1,817,000 shares of its Common Stock. Upon completion of this
offering, the Company owned 80.1% of the outstanding Common Stock of uBid. On
June 7, 1999, the Company divested its ownership in uBid by means of a tax-free
distribution of all of its remaining 7.3 million shares of uBid Common Stock to
the Company's stockholders of record as of May 24, 1999.
In February 1999, the Company formed eCOST.com as a wholly-owned
subsidiary. eCOST.com is a multi-category Internet retailer of computer products
and electronics, and offers a broad selection of name-brand products, most of
which are sold at competitive prices plus itemized fees for processing and
shipping the order. In December 1999, the Company formed eLinux.com as a wholly-
owned subsidiary to focus on products and services directed to the Linux
community.
In 1999, the Company operated in two reportable business segments: Direct
marketing and multi-category Internet retailing. The direct marketing segment
consists of retail sales of personal computers, hardware, software, peripheral
products and consumer electronics under the PCMall, MacMall, ComputAbility and
CCIT brands, and the multi-category Internet segment consists of retail sales of
computer products and electronics under the eCOST.com brand. The Company no
longer operates in the Internet Auction segment as a result of the spin-off of
uBid in 1999. For segment information relating to net sales, operating income
and assets, see Note 12 to the Company's financial statements included herein.
Strategy
The Company's strategy is to be a leading high-volume, cost-effective
direct marketer of a broad range of personal computers, software and related
products, focusing on the Internet and business-to-business markets. Specific
elements of the Company's operating strategy include:
3
Leverage of Internet Leadership Position. The Company considers itself a
leader in Internet e-commerce innovation and intends to continue enhancing its
leadership position on the Internet. The Company was among the first to enter
the Internet auction space with its ubid.com web site. uBid completed a
successful initial public offering ("IPO") in December 1998, and the Company
subsequently distributed to its stockholders all of its remaining shares of uBid
in June 1999.
In March 1999, the Company launched the eCOST.com web site, which offers a
broad selection of name-brand products, most of which are sold at discount
prices. Customers are provided an itemized description of the fees associated
with processing their orders, including a handling fee to cover warehousing,
order processing, systems and overhead costs, and a shipping fee. With the
introduction of eCOST.com, the Company believes that it is among the first full-
spectrum Internet resellers in the personal computing marketplace, offering
customers many different ways to purchase computer hardware, software,
peripherals and consumer electronics.
In February 2000, the Company launched its newest Internet venture,
eLinux.com, to offer complete multi-vendor Linux solutions, including Linux
compatible products, consulting and support services, and community. eLinux.com
serves the rapidly growing Linux community by providing multi-vendor Linux
solutions and custom configurations of Linux-based systems and compatible
products through its secure web site.
Core Business Focus. The Company's core business is built around its
catalog, Internet and business-to-business sales to various customer bases. PC
Mall.com focuses on marketing computers and related products to small businesses
with fewer than 100 employees, as well as high-end consumers. PCM.com Business
Solutions focuses on marketing servers, desktops and network equipment to
businesses with 100 or more employees. CCIT is a field service organization
focusing on Fortune 1000 companies.
Continued Expansion into Outbound Telemarketing. During 1999, the Company
continued to intensify its outbound telemarketing efforts to focus on the under-
served small and medium-size business market. The Company believes this market
represents a high potential growth opportunity. Outbound business-to-business
sales can also be more profitable than inbound sales due to reduced advertising
and higher average order size. The Company's strategy is to rapidly expand its
outbound sales executive workforce and mine its catalog customer database as
well as purchased name lists for prospects. During 1999, the Company continued
to hire experienced outbound telemarketing executives to manage this initiative
and experienced outbound telemarketing recruiters to expand the outbound sales
executive workforce. The Company also commissioned the development of a new
comprehensive training program for outbound sales executives. The Company
expects to continue to invest in outbound telemarketing and prospect its catalog
database for sales leads. The Company expects that its outbound telemarketing
initiative will transform the Company's customer sales mix to an even higher
percentage of business customer sales.
Focus on the Windows/Intel (WINTEL) Market. The Company launched its first
PC catalog, PC Mall, primarily for WINTEL customers, in May 1995. The Company
published seven editions of PC Mall with a total circulation of 11.1 million
copies in 1995. Since then, the PC Mall catalog has expanded into two catalogs,
PC Mall.com and PC Mall Business Solutions, with fourteen editions each in 1999,
and total combined circulation of 21.2 million. Combining ComputAbility's 1999
catalog circulation of 6.3 million, total WINTEL revenues were $410 million, a
13% or $47 million increase over 1998 WINTEL revenue of $363 million.
4
The Company is authorized or otherwise has the ability to sell IBM, Compaq,
Hewlett-Packard, Sony, Toshiba and other name brand computers. The Company has
rapidly become one of the leading catalog resellers of WINTEL products since the
start of its WINTEL initiative in 1995.
Continued Macintosh Marketshare Expansion. Throughout 1999, the Company
continued to be a leading direct marketer of Macintosh products, offering the
full line of Apple as well as related products. The Company's sales of Mac-
related products in 1999 increased 15% to $322 million from $279 million in
1998. During 1999, the Company published fourteen editions of its MacMall
catalog with a circulation of 31.5 million copies, a 5% decrease from the prior
year's 33.0 million circulation and a 13% decrease from the 36.0 million copies
circulated in 1997. Although total catalog circulation has decreased, the
Company has focused on expanding its presence by marketing through its
MacMall.com web site.
Marketing Database Growth. The Company has compiled a proprietary mailing
list of over five million names of previous and potential customers. The
database is continually analyzed to target customer types and increase response
and purchase rates. The Company's response rate (calculated by dividing the
number of orders generated by the number of catalogs distributed) for its
proprietary mailing list during 1999 was higher than its response rate for third
party mailing lists.
Increased Relationship-Based Selling. The Company's sales executives are
highly trained in relationship building with their customers and are
continuously coached to offer higher levels of service. The Company is committed
to relationship-based selling. Each sales executive is trained and empowered to
handle all customer needs including on-going customer service and returns-
related issues. Additionally, sales executives bring other expertise to bear as
needed from within the Company including Novell-trained Certified Network
Engineers (CNE), Microsoft Windows NT specialists (MCSE) and Apple-certified
technicians.
Marketing and Sales
The Company designed its various marketing programs to attract new
customers and to stimulate additional purchases by previous customers. The
Company continuously attracts new customers by selectively mailing catalogs to
prospective customers as well as through advertising on the Internet and in
major computer user magazines, such as PC World, PC Magazine, Computer Shopper
and MacWorld. In addition, the Company obtains the names of prospective
customers through selected mailing lists acquired from various sources,
including manufacturers, suppliers and computer magazine publishers.
The Company sells its products to individual consumers, home offices, small
businesses and large corporations. During 1999, the Company shipped
approximately 874,000 mail order/catalog orders with an average order size of
$639. The Company distributes its catalogs throughout the United States.
Catalogs. The Company published twenty-eight editions of its PC Mall
Business Solutions and PC Mall.com catalogs during 1999 and distributed
approximately 21.2 million catalogs. PC Mall customers receive a catalog several
times a year depending on purchasing history. In addition, the Company includes
a catalog with every order shipped, as well as special promotional flyers and
manufacturers' product brochures.
The Company published fourteen editions of MacMall in 1999 and distributed
approximately 31.5 million catalogs. Active MacMall customers receive a catalog
several times a year depending upon purchasing history, and the Company includes
a catalog with every order shipped, as well as special promotional flyers and
manufacturers' product brochures.
The Company creates all of its catalogs in-house with its own design team
and production artists using a computer-based desktop publishing system. The
in-house preparation of the catalogs streamlines the production process,
provides greater flexibility and creativity in catalog production, and results
in significant cost savings over outside production.
5
The Internet. The Company maintains worldwide web sites on the Internet
that can be accessed via its four catalog names, pcmall.com, macmall.com,
computability.com and ccit-inc.com, as well as eCOST.com and eLinux.com. The
Company also maintains direct links to its PC Mall and eCOST.com web sites on
AOL (through the AOL Shopping Channel), and direct links to its eCOST.com site
on MSN.
The Company offers many advanced Internet features such as on-line
ordering, access to inventory availability and a large product selection with
detailed product information. Sales generated through the Internet have grown
rapidly for the Company as it offers its customers a convenient means of
shopping and ordering its products. In addition, the Company's web sites also
serve as another source of new customers. In 1999, the Company shipped
approximately 336,000 Internet orders, with an average order size of $414.
Outbound and Inbound Telemarketing. The Company believes that much of its
success has come from the quality and training of its telemarketing sales
executives. These sales executives are responsible for assisting customers in
purchasing decisions, answering product pricing and availability questions and
processing product orders. Telemarketing sales executives have the authority to
vary prices within specified parameters in order to meet prices of competitors.
In addition to product training, the sales executives are trained in systems and
networking solutions, sales techniques, phone etiquette and customer service.
Telemarketing sales executives attend frequent training sessions to stay up-to-
date on new products. Sales executives staff the Company's toll-free order
numbers 24 hours a day, seven days a week. Customer service and technical
support personnel assist inbound and outbound telemarketing sales executives.
The Company's phone and computer systems are used for order entry, customer
tracking and inventory management. The computer system maintains a database
listing previous customer purchases, which allows telemarketing sales executives
to make product suggestions that fit each customer's specific buying preferences
and to offer the latest upgrades for products previously purchased from the
Company.
Vendor Supported Marketing. The Company currently has a marketing team
that sells advertising space in the Company's catalogs, advertising on the
Company's Internet sites and vendor supported outbound marketing campaigns.
These advertising sales generate revenues which offset a substantial portion of
the expense of publishing and distributing the catalogs. The same marketing team
develops marketing campaigns to maximize product sales.
National Off-Page Advertising. The Company continuously attracts new
catalog customers and generates orders through large multi-page color
advertisements in major publications such as PC World, PC Magazine, Computer
Shopper and MacWorld. During 1999, the Company purchased 404 pages of magazine
advertising.
Corporate Sales. The specific needs of corporate buyers are fulfilled
through a combination of inbound and outbound full-time sales personnel as well
as a direct sales force through its CCIT subsidiary. The Company's sales staff
builds long-term relationships with corporate customers through regular phone
contact and personalized service. Corporate customers may choose from several
purchase or lease options for financing product purchases, and the Company
extends credit terms to certain corporate customers.
Customer Return Policy. The Company offers a 30-day return policy on a
number of its products subject to vendor terms and conditions. Returns are
monitored to identify trends in product acceptance and defects, to enhance
customer satisfaction and to reduce overall returns.
Products and Merchandising
The Company offers hardware, software, peripherals, components and
accessories for users of computer products, as well as consumer electronics
equipment. The Company screens new products and selects products for inclusion
in its catalogs and web sites based on features, quality, sales trends, price,
margins, cooperative/market development funds and warranties. The Company offers
its customers other value-added services, such as the ability to purchase
systems that have been specifically configured to meet the customer's
requirements. Through frequent mailings of its catalogs and e-mails to its
customers, the Company is able to quickly introduce new products and replace
slower selling products with new products.
6
The following table sets forth the Company's net sales and percentage of
net sales by major product category for the periods presented.
Year Ended December 31,
(in millions of dollars)
1997 % 1998 % 1999 %
------ ----- ------ ----- ------ -----
Computer systems........ $231.1 42.3% $270.9 42.2% $321.2 43.9%
Peripherals, components
and accessories...... 247.9 45.4 291.7 45.4 322.0 44.0
Software................ 60.9 11.2 68.5 10.7 72.0 9.8
Other (1)............... 6.2 1.1 10.9 1.7 16.8 2.3
------ ----- ------ ----- ------ -----
Total.............. $546.1 100.0% $642.0 100.0% $732.0 100.0%
====== ===== ====== ===== ====== =====
(1) Other consists primarily of other electronic products, income from labor
charges and sales of extended warranties.
Computer Systems. In connection with the Company's expansion into the
WINTEL market, the Company has obtained catalog sales authorizations or
otherwise has the ability to sell WINTEL products from the major WINTEL-platform
hardware manufacturers, including IBM, Compaq, Hewlett-Packard, Sony, Toshiba
and others. The Company is also authorized to sell the full line of Apple
hardware.
Peripherals, Components and Accessories. The Company offers a large
selection of peripheral and component products from manufacturers such as Apple,
Hewlett-Packard, Sony, Epson, 3Com, US Robotics, IBM, Iomega and Compaq.
Peripherals and components include printers, modems, monitors, data storage
devices, add-on circuit boards, connectivity products and communications
products. The accessories offered by the Company include a broad range of
computer-related items and supplies such as diskettes, cables and connectors.
Software. The Company sells a wide variety of software packages in the
business and personal productivity, utility, language, educational and
entertainment categories, including word processing, spreadsheet and database
software. The Company offers a large number of software programs and licenses
from established vendors, such as Microsoft, Corel, Adobe, Symantec, Quark,
Lotus, Macromedia and Intuit as well as numerous specialty products from new and
emerging vendors. The Company also markets upgrades from certain vendors, such
as Symantec, Corel, Lotus and Microsoft, which the Company believes offer
incremental revenue opportunities.
Purchasing and Inventory
The Company believes that effective purchasing is a key element of its
business strategy to provide name brand computer products and related software
and peripherals at competitive prices. The Company believes that its high volume
of sales results in increased purchasing power with its primary suppliers,
resulting in volume discounts, favorable product return policies and vendor
promotional allowances. During 1999, the Company purchased products from over
560 vendors. During 1997, 1998 and 1999, products manufactured by Apple
represented approximately 21.4%, 20.0% and 25.4% of net sales, respectively. The
Company is also linked electronically with four large distributors, which allows
account executives to view distributor product availability on line and drop-
ship product directly to their customers. The benefits of this program, known as
virtual warehouse, include reduced inventory carrying costs and improved
inventory turns. The Company intends to expand its use of virtual warehouse in
the future.
7
Most key vendors have agreements to provide market development funds to the
Company, whereby such vendors finance portions of the cost of catalog
publication and distribution based upon the amount of coverage given in the
catalogs for their products. Termination or interruption of the Company's
relationships with its vendors, or modification of the terms of or
discontinuance of the Company's agreements with its vendors, could adversely
affect the Company's operating results. The Company's success is dependent in
part upon the ability of its vendors to develop and market products that meet
the changing requirements of the marketplace. As is customary in the industry,
the Company has no long-term supply contracts with any of its vendors.
Substantially all of the Company's contracts with its vendors are terminable
upon 30 days' notice or less.
The Company attempts to manage its inventory position to generate the
highest levels of customer satisfaction possible while limiting inventory risk.
The Company believes that it has increased its ability to provide constrained
products, which it believes is an important competitive advantage; and the
Company invested in this strategy heavily during 1999. The Company's average
annual inventory turns were 9.9 times in 1997, 13.5 times in 1998 and 16.4 times
in 1999. Inventory levels may vary from period to period, due in part to
increases or decreases in sales levels, the Company's practice of making large-
volume purchases when it deems the terms of such purchases to be attractive and
the addition of new manufacturers and products. The Company has negotiated
agreements with many of its vendors that contain price protection provisions
intended to reduce the Company's risk of loss due to manufacturer price
reductions. The Company currently has such rights with respect to products which
it purchases from Apple, IBM, Compaq, Hewlett Packard and certain other vendors;
however, such rights vary by product line, have other conditions and limitations
and can be terminated or changed at any time.
The market for computers, computer products, peripherals, software and
electronics is characterized by rapid technological change and a growing
diversity of products. The Company's success depends in large part on its
ability to identify and obtain the right to market products that will meet the
changing requirements of the marketplace and to obtain sufficient quantities of
product to meet changing demands. There can be no assurance that the Company
will be able to identify and offer products necessary to remain competitive or
avoid losses related to excess or obsolete inventory.
Distribution
The Company operates a full-service 325,000 square foot distribution center
in Memphis, Tennessee. The centralized distribution operations, strategically
located near the Federal Express hub in Memphis, allow most orders of in-stock
products accepted by 10:00 p.m. Eastern Standard Time to be shipped for delivery
by 10:30 a.m. the following day via Federal Express. Upon request, orders may
also be shipped at a lower cost by United Parcel Ground Service. As of December
31, 1999, the Company subleases 175,600 square feet of the Company's 325,000
square foot facility to uBid, Inc. under two sublease agreements. The first
sublease agreement covers 105,600 square feet, and is co-terminus with the
building lease. The remaining 70,000 square feet is covered in a sublease
agreement expiring in 2001.
When an order is entered into the system, a computer credit check or credit
card verification is performed and, if approved, the order is electronically
transmitted to the warehouse area, and a packing slip is printed for order
fulfillment. Orders fulfilled by certain distributors linked electronically
with the Company are transmitted directly to their warehouses. All inventory
items are bar coded and located in computer-designated areas which are easily
identified on the packing slip. All orders are checked with bar code scanners
prior to final packing to ensure that each order is packed correctly.
The Company believes that its existing distribution facilities are
currently adequate for its needs.
Management Information Systems
The Company has committed significant resources to the development of a
sophisticated computer system which is used to manage all aspects of its
business. The Company's computer system supports telemarketing, marketing,
purchasing, accounting, customer service, warehousing and distribution, and
facilitates the preparation of daily operating control reports which provide
concise and timely information
8
regarding key aspects of its business. The system allows the Company to, among
other things, monitor sales trends, make informed purchasing decisions and
provide product availability and order status information. In addition to the
main computer system, the Company has a system of networked personal computers,
which facilitates data sharing. The Company also applies its management
information systems to the task of managing its inventory. The Company currently
operates its management information system using a Hewlett Packard HP3000
Enterprise System and has a back-up system available in the event of a system
failure. The Company believes that in order to remain competitive it will be
necessary to upgrade its management information systems on a continuing basis.
The Company's success is in part dependent on the accuracy and proper
utilization of its management information systems and its telephone system. In
addition to the costs associated with system upgrades, the transition to and
implementation of new or upgraded hardware or software systems can result in
system delays or failures. Any interruption, corruption, degradation or failure
of the Company's management information systems or telephone system could impact
its ability to receive and process customer orders on a timely basis.
Retail Computer Showrooms
During the first quarter of 1998, the Company closed seven retail showrooms
to focus its efforts on its business-to-business and Internet channels of
distribution. The Company recorded a one-time pretax restructuring charge of
$10.5 million relating to exit costs associated with the closing of retail
operations. Recorded in selling, general and administrative costs were $3.1
million of goodwill write-offs, $1.9 million of fixed asset write-offs, $1.5
million of reserves for lease exit costs, and $0.3 million of employee-related
severance costs. Recorded as cost of sales were $3.7 million of reserves for
store inventory. The Company currently operates one retail computer showroom,
located in Santa Monica, California.
Competition
The retail business for personal computers and related products is highly
competitive. The Company competes with other direct marketers, including
MicroWarehouse, CDW, Multiple Zones, Insight Direct, PC Connection and Global
Direct. The Company also competes with Internet retailers such as buy.com,
onvia.com, egghead.com and beyond.com. In addition, the Company competes with
computer retail stores and resellers including superstores such as CompUSA and
Best Buy, corporate resellers such as Compucom, Entex and Inacom, certain
hardware and software vendors such as Gateway and Dell Computer which sell
directly to end users, and other direct marketers of hardware, software and
computer-related products. Barriers to entry are relatively low in the direct
marketing industry and the risk of new competitors entering the market is high.
The market in which the Company's retail showroom operates is also highly
competitive.
The manner in which personal computers, software and related products are
distributed and sold is changing, and new methods of sales and distribution have
emerged, such as the Internet. Technology now allows software vendors the
ability to sell and download programs directly to consumers, if so desired. In
addition, in recent years the industry has generated a number of new, cost-
effective channels of distribution such as computer superstores, consumer
electronic and office supply superstores, national direct marketers and mass
merchants. Computer resellers are consolidating operations and acquiring or
merging with other resellers to achieve economies of scale and increased
efficiency. In addition, traditional retailers have entered and may increase
their penetration into the direct mail channel. The current industry
reconfiguration and the trend toward consolidation could cause the industry to
become even more competitive, further increase pricing pressures and make it
more difficult for the Company to maintain its operating margins or to increase
or maintain the same level of net sales or gross profit.
Although many of the Company's competitors have greater financial resources
than the Company, the Company believes that its ability to offer the consumer a
wide selection of products, at competitive prices, with prompt delivery and a
high level of customer service, and its good relationships with its vendors and
suppliers, allow it to compete effectively. There can be no assurance that the
Company can continue to compete effectively against existing or new competitors
that may enter the market. The Company believes
9
that competition may increase in the future, which could require the Company to
reduce prices, increase advertising expenditures or take other actions which may
have an adverse effect on the Company's operating results.
Employees
As of December 31, 1999, the Company had 980 full-time employees, including
132 people at the Company's distribution center. The Company emphasizes the
recruiting and training of high quality personnel and, to the extent practical,
promotes people to positions of increased responsibility from within the
Company. Each employee initially receives training appropriate for his or her
position, followed by varying levels of training in computer technology,
communication and leadership. New account executives participate in an intensive
six-week training program, during which time they are introduced to the
Company's philosophy, available resources, products and services, as well as
basic and advanced sales skills. Training for specific product lines and
continuing education programs for all employees are conducted on an ongoing
basis, supplemented by vendor-sponsored training programs for all sales
executives and technical support personnel.
The Company's employees are generally compensated on a basis that rewards
performance and the achievement of identified goals. For example, sales
executives receive compensation pursuant to a commission schedule which is based
primarily upon aggregate sales, gross profit dollars and gross profit percentage
generated from their sales efforts. The Company believes that these incentives
positively impact its performance and operating results.
The Company considers its employee relations to be good. None of the
Company's employees is represented by a labor union, and the Company has
experienced no work stoppages.
Since its formation, the Company has experienced rapid growth. As a result
of this growth, the Company has added a significant number of employees and has
been required to expend considerable effort in training these new employees.
Properties
The Company's facilities at December 31, 1999 were as follows:
Description Sq. Ft. Location
- --------------------------------------------- ---------- -------------------------
Creative Computers Corporate Headquarters.... 143,532 Torrance, CA
Distribution Center.......................... 325,000 Memphis, TN
Retail Showroom.............................. 13,050 Santa Monica, CA
CCIT Corporate Headquarters.................. 25,840 Elk Grove Village, IL
Kansas Property.............................. 32,800 Lenexa, KS
CCIT Colorado Corporate Sales................ 2,315 Englewood, CO
ComputAbility Corporate Headquarters......... 15,000 Milwaukee, WI
ComputAbility Sales Office................... 15,000 Milwaukee, WI
The Company leases all of its facilities, except for the following: 9,750
square feet of the Santa Monica retail showroom, the Lenexa property, and the
ComputAbility Corporate headquarters, each of which is owned by the Company.
The Company's distribution center serves the Company's catalog, ComputAbility
and eCOST.com operations, as well as its retail showrooms, and includes
shipping, receiving, warehousing and administrative space. The Company
subleases 175,600 square feet of its distribution center to uBid Inc. The
following leases have remaining terms greater than two years: Creative Computers
corporate headquarters, Memphis distribution center and CCIT corporate
headquarters. All of the other leases have remaining terms less than two years.
During the fourth quarter of 1997, the Company consolidated its
10
headquarters facility and its telemarketing operations into a 160,000 square
foot building in Torrance, California. The one-time charge for the move was $0.8
million.
During the first quarter of 1998, the Company closed all of its retail
showrooms except for its Santa Monica showroom. The Company recorded a one-time
$1.5 million reserve for lease exit costs during the first quarter of 1998. The
Company intends to sell its Lenexa, Kansas building and its ComputAbility
Corporate Headquarters.
In February 2000, the Company signed an agreement to lease 35,503 square
feet in Milwaukee, Wisconsin to support the expansion of the Wisconsin sales
force. This lease will replace the existing ComputAbility Sales Office lease,
which expired in January 2000, and the ComputAbility Corporate Headquarters.
Regulatory and Legal Matters
The direct response business as conducted by the Company is subject to the
Merchandise Mail Order Rule and related regulations promulgated by the Federal
Trade Commission and laws or regulations directly applicable to access to or
commerce on the Internet. While the Company believes it is currently in
compliance with such laws and regulations and has implemented programs and
systems to address its ongoing compliance with such regulations, no assurances
can be given that new laws or regulations will not be enacted or adopted which
might adversely affect the Company's operations. Due to the increasing
popularity and use of the Internet, it is possible that a number of laws and
regulations may be adopted with respect to the Internet. The growth and
development of the market for Internet commerce may prompt calls for more
stringent consumer protection laws that may impose additional burdens on those
companies conducting business over the Internet. The adoption of any additional
laws or regulations may decrease the growth of the Internet, which, in turn,
could decrease the demand for and growth of the Company's Internet-based sales.
The Company, or various subsidiaries, currently collects and remits sales
tax only on sales of its products to residents of the states in which the
Company or its respective subsidiaries has a physical presence. Various states
have sought to impose on direct marketers with no physical presence in the
taxing state the burden of collecting state sales and use taxes on the sale of
products shipped to those states' residents, and it is possible that such a
requirement could be imposed in the future.
A number of proposals have been made at the federal, state and local level,
and by certain foreign governments, that would impose additional taxes on the
sale of goods and services over the Internet. In October 1998, Congress passed
the Internet Tax Freedom Act (the "ITFA"). The stated purpose of the ITFA is
neutral tax treatment of economic activity, electronic or otherwise. The ITFA
prohibits state and local taxes that discriminate against or single out the
Internet. As part of the ITFA, Congress created a committee to conduct an 18-
month study of whether use of or sales on the Internet should be taxed and, if
so, how taxes could be applied without subjecting the Internet and electronic
commerce to special, discriminatory or multiple taxation. Although it is not an
issue specific to the Internet, one of the agenda items for the committee set up
as part of the ITFA is a review of the sales tax "nexus" issue as it relates to
all direct marketers. There can be no assurance the committee's report to
Congress will not ultimately result in a modification by legislation of the
Supreme Court's favorable rulings regarding sales and use taxation on out of
state marketers.
11
Executive Officers
The executive officers of the Company as of March __, 2000 and their
respective ages and positions are as follows:
Name Age Position
---- --- --------
Frank F. Khulusi........... 33 Chairman of the Board and
Chief Executive Officer
Scott W. Klein............. 42 President
Theodore R. Sanders........ 45 Chief Financial Officer
Daniel J. DeVries.......... 38 Executive Vice President - Marketing
and Sales
The following is a biographical summary of the experience of the executive
officers:
Frank F. Khulusi is a co-founder of the Company and has served as Chairman
of the Board and Chief Executive Officer of the Company since the Company's
inception in 1987, and served as President until July 1999. Mr. Khulusi attended
the University of Southern California.
Scott W. Klein has served as President of Creative Computers since July
1999. In May 1999, Mr. Klein joined the Creative Computers organization as the
President and CEO of eCOST.com. Prior to joining the Company, Mr. Klein was
Executive Vice President and COO of PrimeSource Building Products, Inc. from
1984 to May 1999, where he oversaw sales, marketing, distribution and MIS
and held a position on the Board of Directors. From 1981 to 1984, Mr.
Klein was a Director of Marketing for Pepsi Co. Mr. Klein also worked in Brand
Management at Procter & Gamble. Mr. Klein received a B.S. degree in Accounting
from Syracuse University.
Theodore R. Sanders has served as Chief Financial Officer since September
1998 and was Vice President - Controller of the Company from May 1997 to
September 1998. Prior to joining the Company, Mr. Sanders spent ten years with
the Pittston Company in various senior finance roles including Controller of its
Burlington Air Express Global division and Director of Internal Audit. Mr.
Sanders started his career with Deloitte & Touche and rose to the position of
Manager. Mr. Sanders is a C.P.A. and received a B.S.B.A. degree from Nichols
College.
Daniel J. DeVries has served as Executive Vice President since February
1996 and was Senior Vice President from October 1994 to that time. Mr. DeVries
is responsible for all marketing, sales, purchasing and the retail showroom. Mr.
DeVries' marketing responsibilities include vendor co-op marketing,
merchandising, database marketing and Internet marketing. From April 1993 to
October 1994, he held various sales and marketing positions with the Company.
From July 1988 to April 1993, Mr. DeVries was a Regional Manager for Sun
Computers, a computer retailer.
CERTAIN FACTORS AFFECTING FUTURE RESULTS
This Annual Report on Form 10-K, including the sections entitled
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other sections of this Report, contain forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, and Section 21E of the Securities Exchange Act of 1934. Words such as
"expect," "anticipate," "intend," "plan," "believe," "estimate," "may," "will,"
"should," "seeks" and variations of such words and similar expressions are
intended to identify such forward-looking statements. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995, and the Company is including this statement for purposes of
complying with these safe harbor provisions. The Company has based these
12
forward-looking statements on its current expectations and projections about
future events. These forward-looking statements are not guarantees of future
performance and are subject to risks, uncertainties and assumptions, and actual
results could differ materially as a result of several factors, including those
set forth under this section entitled "Certain Factors Affecting Future Results"
and elsewhere herein. The Company undertakes no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
(1) The loss of a key vendor or decline in demand for products of a key
vendor, such as Apple, may reduce sales and adversely affect operating
results.
(2) Intense competition may lead to reduced prices and lower gross
margins.
(3) The Company's narrow margins magnify the impact on operating results
of variations in operating performance. A number of factors may reduce
the Company's margins even further.
(4) Seasonal variations in the demand for products and services, as well
as the introduction of new products, may cause variations in the
Company's quarterly results.
(5) The availability (or lack thereof) of capital on acceptable terms may
hamper the Company in its efforts to fund its increasing working
capital needs.
(6) The failure of the Company to adequately manage its growth, including
the integration of acquired companies, may adversely impact the
Company's results of operations.
(7) A failure of the Company's information systems may adversely impact
the Company's results of operations.
(8) The loss of a key executive officer or other key employee may
adversely impact the Company's operations.
(9) The inability of the Company to obtain products on favorable terms may
adversely impact the Company's results of operations.
(10) The Company's operations may be adversely impacted by an acquisition
that is either (i) not suited for the Company or (ii) improperly
executed.
(11) The Company's financial condition may be adversely impacted by a
decline in value of a portion of the Company's inventory.
(12) The failure of certain shipping companies to deliver product to the
Company, or from the Company to its customers, may adversely impact
the Company's results of operations.
(13) The failure of the Company to respond adequately to changes in
consumer preferences, such as the use of the Internet for purchasing,
may adversely affect the Company's business and results of operations.
(14) Rapid technological change may alter the market for the Company's
products and services, requiring the Company to anticipate such
technological changes, to the extent possible.
(15) The failure of the Company to attract and retain skilled personnel may
adversely affect the Company's business and results of operations.
It is not reasonably possible to itemize all of the many factors and
specific events that could affect the Company and/or the computer products and
electronics industry as a whole. However, the discussion below discusses in more
detail some of the foregoing factors, as well as additional factors which may
affect the
13
Company's actual results and cause such results to differ materially from those
projected, forecasted, estimated, budgeted or otherwise expressed in any
"forward-looking statements."
Our addition of a new business focus could subject us to risks commonly
associated with a new company
We have historically operated as a direct marketer of computer products,
and have only recently expanded our business model to include a focus on the
Internet and business-to-business markets by developing our portfolio of web
site properties. We have only been active in this new line of business since
1995 when we launched the PCMall.com web site. We established uBid.com, an
online auction web site, in 1997, our eCOST.com web site in March 1999 and our
eLinux.com web site in February 2000, and plan to continue our focus on the
Internet and business-to-business market in the future. We do not have a
significant operating history upon which you can evaluate our new business
focus, and you should not rely upon past performance to predict our future
performance. In adding a new business focus, we expect that we will have to make
changes to our business operations, sales and implementation practices, customer
service and support operations and management focus. We are also facing new
risks and challenges, including a lack of meaningful historical financial data
upon which to plan future budgets, reliance on the growth and use of the
Internet to generate commercial opportunities, competition from a wider range of
sources, the need to develop strategic relationships and other risks. We cannot
guarantee that we will be able to successfully transition to this new business
focus.
Dependence on Apple
The Company is dependent on sales of Apple computers and software and
peripheral products used with Apple computers. Products manufactured by Apple
represented approximately 21.4%, 20.0% and 25.4% of the Company's net sales in
1997, 1998 and 1999, respectively. A decline in sales of Apple computers or a
decrease in supply of or demand for software and peripheral products for such
computers could have a material adverse impact on the Company's business. During
parts of 1997 and 1999, certain Apple computers were in short supply. A
continuation of such shortages or future shortages could adversely affect the
Company's operating results. The Company is an authorized dealer for the full
retail line of Apple products; however, the Company's dealer agreement with
Apple is terminable upon 30 days' notice. The Company's business would be
adversely affected if all or a portion of the line of Apple products was no
longer available to the Company. The Company's success is, in part, dependent
upon the ability of Apple to develop and market products that meet the changing
requirements of the marketplace. To the extent that these products are not
available to the Company, the Company could encounter increased price and other
competition, which would adversely affect the Company's business, financial
condition and results of operations.
Rapid Growth
Since its formation, the Company has experienced rapid growth. Net sales
have grown from $8.7 million in 1990 to $732.0 million in 1999. The Company's
catalog sales grew from $117.9 million in 1994 to $558.2 million in 1999.
Internet sales on its pcmall.com, macmall.com, computability.com, ecost.com and
ccit-inc.com web sites grew from $15.6 million in 1997 to $139.0 million in
1999. As a result of the Company's shift from the retail showroom to the
Internet sales and catalog distribution channels, retail showroom sales have
decreased from 28.0% of net sales in 1994 to 4.7% in 1999. During the first
quarter of 1998, the Company closed seven retail showrooms to focus its efforts
on its catalog, corporate and Internet channels of distribution. The Company
recorded a one-time pretax restructuring charge of $10.5 million in the first
quarter of 1998 relating to exit costs, asset write-offs, other charges and
related goodwill. In response to the growth in catalog sales, the Company has
rapidly added a significant number of employees and has been required to expend
considerable efforts in training these new employees. This growth has placed
strains on the Company's management, resources and facilities. As part of its
growth strategy, the Company acquired Elek-Tek and ComputAbility in 1997 and
may, in the future, acquire other companies in the same or complementary lines
of business. These acquisitions and any such acquisition and the ensuing
integration of the operations of the acquired company with those of the Company
place additional demands on the Company's management, operating and financial
resources. The Company's success will, in part, be dependent upon the ability of
the Company to manage growth effectively. In addition, the Company's business
and growth could be affected by the spending patterns of existing or prospective
customers, the cyclical nature of capital expenditures of businesses, continued
competition and pricing pressures, changes in the rate of development of new
technologies and new products by manufacturers, acceptance by end-users and
other trends in the general economy. There can be no assurance that the
Company's historical growth rates will continue in the future.
In connection with the Company's expansion into the WINTEL market, the
Company has obtained catalog sales authorizations or otherwise has the ability
to sell WINTEL products from certain major hardware manufacturers, including
IBM, Compaq, Hewlett-Packard, Sony, Toshiba, and others. Many of its current
vendors of peripherals, components, accessories and software also offer WINTEL
products. While the Company has been successful to date in becoming a major
catalog reseller of WINTEL products, no assurances can be given that the Company
will be able to maintain that position.
Competition
The retail business for personal computers, electronics and related
products is highly competitive, based primarily on price, product availability,
speed and accuracy of delivery, effectiveness of sales and
14
marketing programs, credit availability, ability to tailor specific solutions to
customer needs, quality and breadth of product lines and services, and
availability of technical or product information. The Company competes with
other direct marketers, including MicroWarehouse, CDW, Multiple Zones, Insight
Direct, PC Connection and Global Direct. The Company also competes with Internet
retailers such as buy.com, egghead.com and beyond.com. In addition, the Company
competes with computer retail stores and resellers, including superstores, such
as CompUSA, Best Buy, corporate resellers such as Compucom, Entex and Inacom,
certain hardware and software vendors, such as Gateway and Dell Computer, which
sell directly to end users, and other direct marketers of hardware, software and
computer-related products. In the direct marketing and Internet retail
industries, barriers to entry are relatively low and the risk of new competitors
entering the market is high. Certain existing competitors of the Company have
substantially greater financial resources than the Company. There can be no
assurance that the Company can continue to compete effectively against existing
competitors, consolidations of competitors or new competitors that may enter the
market. In addition, price is an important competitive factor in the personal
computer hardware, software and peripherals market and the market for
electronics products, and there can be no assurance that the Company will not be
subject to increased price competition, which may have an adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the Company will not lose market share or that it will not be
forced in the future to reduce its prices in response to the actions of its
competitors and thereby experience a further reduction in its gross margins.
Narrow Operating Margins
As a result of intense price competition in the computer products and
electronics industry, the Company's margins have historically been narrow and
are expected to continue to be narrow. These narrow margins magnify the impact
on operating results of variations in operating costs and of adverse or
unforeseen events.
Potential Quarterly Fluctuations
The Company experiences variability in its net sales and net income on a
quarterly basis as a result of many factors. These factors include the frequency
of catalog mailings, introduction or discontinuation of new catalogs, the
introduction of new products or services by the Company and its competitors,
changes in prices from suppliers, the loss or consolidation of a significant
supplier or customer, general competitive conditions including pricing, the
Company's ability to control costs, the timing of capital expenditures, the
condition of the personal computer industry and electronics in general, seasonal
shifts in demand for computer and electronics products, industry announcements
and market acceptance of new products or upgrades, deferral of customer orders
in anticipation of new product applications, product enhancements or operating
systems, the relative mix of products sold during the period, inability of the
Company to obtain adequate quantities of products carried in its catalogs,
delays in the release by suppliers of new products and inventory adjustments and
expenditures by the Company on new business ventures. The Company's planned
operating expenditures each quarter are based on sales forecasts for the
quarter. If sales do not meet expectations in any given quarter, operating
results for the quarter may be materially adversely affected. The Company's
narrow margins may magnify the impact of these factors on the Company's
operating results. The Company believes that period-to-period comparisons of its
operating results should not be relied upon as an indication of future
performance. In addition, the results of any quarterly period are not
necessarily indicative of results to be expected for a full fiscal year. In
certain future quarters, the Company's operating results may be below the
expectations of public market analysts or investors. In such event, the market
price of the Company's Common Stock could be materially adversely affected.
Dependence on Vendors
The Company purchases all of its products from vendors. Certain key
vendors, including IBM, Hewlett Packard, Compaq and Apple, provide the Company
with trade credit as well as substantial incentives in the form of discounts,
credits and cooperative advertising. Most key vendors have agreements to
provide, or otherwise have consistently provided, market development funds to
the Company, whereby such vendors finance portions of the cost of catalog
publication and distribution based upon the amount of coverage given in the
catalogs to their respective products. Termination or interruption of the
Company's relationships with one or more of these vendors, including Apple, or
modification of the terms or
15
discontinuance of the agreements with these vendors, could adversely affect the
Company's operating income and cash flow. The Company's success is dependent in
part upon the ability of its vendors to develop and market products that meet
the changing requirements of the marketplace. Substantially all of the Company's
contracts with its vendors are terminable upon 30 days' notice or less. In most
cases, the Company has no guaranteed price or delivery arrangements with its
suppliers. As a result, the Company has experienced and may in the future
experience short-term inventory shortages on certain products. In addition,
manufacturers who currently sell their products through the Company may decide
to sell their products directly or through resellers or channels other than the
Company. Further, the personal computer industry experiences significant product
supply shortages and customer order backlogs from time to time due to the
inability of certain manufacturers to supply certain products as needed. There
can be no assurance that suppliers will be able to maintain an adequate supply
of products to fulfill the Company's customers' orders on a timely basis or that
the Company will be able to obtain particular products or that a product line
currently offered by suppliers will continue to be available. Similarly, there
can be no assurance that the Company will be able to obtain authorizations from
new vendors which may introduce new products that create market demand.
Business Interruption; Facilities
The Company believes that its success to date has been, and future results
of operations will be, dependent in large part upon its ability to provide
prompt and efficient service to its customers. The Company has taken several
precautionary steps to help minimize the impact of disasters that might cause
business interruptions. There can be no assurance that a disruption will not
occur; however, any disruption of the Company's day-to-day operations including
those caused by natural disasters could have a material adverse effect upon the
Company and any interruption, corruption, degradation or failure of the
Company's management information systems, distribution center, web site or
telephone system could impair its ability to receive and process customer orders
and ship products on a timely basis. The Company does not have a redundant
telephone system and does not have a backup or redundant call center.
Changing Methods of Distribution
The manner in which computer and electronics products are distributed and
sold is changing, and new methods of sale and distribution, such as the
Internet, have emerged. Computer hardware and software vendors have sold, and
may intensify their efforts to sell, their products directly to end users. From
time to time, certain vendors have instituted programs for the direct sale of
large quantities of hardware and software to certain major corporate accounts.
These types of programs may continue to be developed and used by various
vendors. Vendors also may attempt to increase the volume of software products
distributed electronically to end users' personal computers. Any of these
competitive programs, if successful, could have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Independent Shipping Companies
The Company relies almost entirely on arrangements with independent
shipping companies, especially Federal Express and UPS, for the delivery of its
products. The disruption or termination of the Company's arrangements with
Federal Express, UPS or other shipping companies, or the failure or inability of
one or more shipping companies to deliver products from the Company to its
customers, or from suppliers to the Company, could have a material adverse
effect on the Company's business, financial condition and results of operations.
Postage, Shipping and Paper Costs
Postage and shipping are significant expenses in the operation of the
Company's business. The Company ships its products to customers by overnight
delivery and ground delivery services and generally mails its catalogs through
the U.S. Postal Service. Any increases in postal or shipping rates in the future
could have a material adverse effect on the business, financial condition and
results of operations. The cost of paper is also a significant expense of the
Company in printing its catalogs. The cost of paper has fluctuated significantly
over the last several years. While the Company believes that it may be able to
16
recoup a portion of any increased postage and paper costs through increases in
vendor advertising rates, no assurance can be given that such advertising rate
increases can be sustained or that they will offset all of the increased costs.
Risk of Technological Changes and Inventory Obsolescence
The market for personal computers, peripherals, software and electronics
products is characterized by rapid technological change and a growing diversity
of products. The Company's success depends in large part on its ability to
identify and obtain the right to market products that will meet the changing
requirements of the marketplace. There can be no assurance that the Company will
be able to identify and offer products necessary to remain competitive or avoid
losses related to excess and obsolete inventory. The Company currently has
limited return rights with respect to products which it purchases from Apple,
IBM, Compaq, Hewlett Packard and certain other vendors; however, such rights
vary by product line, have other conditions and limitations and can be
terminated or changed at any time.
State Sales Tax Collection
The Company, or various subsidiaries, currently collects and remits sales
tax on sales of products to residents of the states that it has legal presence
in. Various states have sought to impose on direct marketers the burden of
collecting state sales taxes on the sale of products shipped to those states'
residents. The U.S. Supreme Court has ruled that the various states, absent
Congressional legislation, may not impose tax collection obligations on an out-
of-state mail order company whose only contacts with the taxing state are
distribution of catalogs and other advertisement materials through the mail, and
whose subsequent delivery of purchased goods is by mail or interstate common
carriers. A New York Court of Appeals case imposed tax collection obligations on
two Vermont companies, one of which was a mail order company, whose contacts
with New York consisted of visiting the state several times a year to aid
customers or visiting showrooms stocking their goods. The Company believes its
operations are different from the operations of the companies in the New York
case and thus do not give rise to tax collection obligations. However, the
Company cannot predict the level of contact with any state which would give rise
to future or past tax collection obligations within the parameters of the
Supreme Court case. It is possible that federal legislation could be enacted
that would permit states to impose sales tax collection obligations on out-of-
state mail order companies and if enacted, the imposition of a tax collection
obligation on the Company may result in additional administrative expenses to
the Company and price increases to its customers that could adversely affect the
Company's business, financial condition and results of operations.
The tax treatment of the Internet and e-commerce is currently unsettled. A
number of proposals have been made at the federal, state and local level and by
certain foreign governments that could impose taxes on the sale of goods and
services and certain other Internet activities. In 1998, the Internet Tax
Freedom Act was signed into law, placing a three-year moratorium on new state
and local taxes on Internet commerce. However, there can be no assurance that
future laws imposing taxes or other regulations on commerce over the Internet
would not substantially impair the growth of e-commerce and as a result have a
material adverse effect on the Company's business, results of operations and
financial condition.
Industry Evolution and Price Reductions
The personal computer industry is undergoing significant change. In
addition, in recent years a number of new, cost-effective channels of
distribution have developed in the industry, such as the Internet, computer
superstores, consumer electronic and office supply superstores, national direct
marketers and mass merchants. Computer resellers are consolidating operations
and acquiring or merging with other resellers and/or direct marketers to achieve
economies of scale and increased efficiency. The current industry
reconfiguration and the trend towards consolidation could cause the industry to
become even more competitive, further increase pricing pressures and make it
more difficult for the Company to maintain its operating margins or to increase
or maintain the same level of net sales or gross profit. Declining prices,
resulting in part from technological changes, may require the Company to sell a
greater number of products to achieve the same level of net sales and gross
profit. Such a trend could make it more difficult for the Company to continue to
increase its net sales and earnings growth. In addition, the personal computer
17
market has experienced rapid growth. If the growth rate of the personal computer
market were to decrease, the Company's business, financial condition and
operating results could be adversely affected.
Management Information Systems
The Company's success is in part dependent on the accuracy and proper
utilization of its management information systems, including its telephone
system. The Company's ability to analyze data derived from its management
information systems to increase product promotions, manage inventory and
accounts receivable collections, to purchase, sell and ship products efficiently
and on a timely basis and to maintain cost-efficient operations, are each
dependent upon the quality and utilization of the information generated by its
management information systems. During 1995, the Company significantly upgraded
its management information system hardware and software. The Company believes
that to remain competitive it will be necessary to upgrade its management
information systems on a continuing basis. In addition to the costs associated
with such upgrades, the transition to and implementation of new or upgraded
hardware or software systems can result in system delays or failures which could
impair the Company's ability to receive and process orders and ship products in
a timely manner. The Company does not currently have a redundant or back-up
telephone system, and any interruption in telephone service including those
caused by natural disasters could have a material adverse effect on the
Company's business, financial condition and results of operations.
Dependence on Senior Management
The Company's future performance will depend to a significant extent upon
the efforts and abilities of certain key management personnel, including Frank
Khulusi, Chairman of the Board and Chief Executive Officer. The Company has a $3
million key man life insurance policy on Mr. Khulusi. The loss of service of one
or more of the Company's key management personnel could have an adverse effect
on the Company's business. The Company's success and plans for future growth
will also depend in part on management's continuing ability to hire, train and
retain skilled personnel in all areas of its business.
Management of Growth
The rapid growth of the Company's business has required the Company to make
significant recent additions in personnel and has significantly increased the
Company's working capital requirements. Although the Company has experienced
significant sales growth in recent years, such growth should not be considered
indicative of future sales growth. Such growth has resulted in new and increased
responsibilities for management personnel and has placed and continues to place
significant strain upon the Company's management, operating and financial
systems, and other resources. There can be no assurance that this strain will
not have a material adverse effect on the Company's business, financial
condition, and results of operations, nor can there be any assurance that the
Company will be able to attract or retain sufficient personnel to continue the
expansion of its operations. Also crucial to the Company's success in managing
its growth will be its ability to achieve additional economies of scale. There
can be no assurance that the Company will be able to achieve such economies of
scale, and the failure to do so could have a material adverse effect upon the
Company's business, financial condition and results of operations.
Acquisitions
As part of its growth strategy, the Company acquired two marketers of
computers and computer-related products in 1997 and may continue to pursue
acquisitions of companies that would either complement or expand its existing
business. No assurance can be given that the benefits expected from the
integration of acquired companies will be realized. In addition, acquisitions
involve a number of risks and difficulties, including expansion into new
geographic markets and business areas, the diversion of management's attention
to the assimilation of the operations and personnel of the acquired company, the
integration of the acquired company's management information systems with those
of the Company, potential short-term adverse effects on the Company's operating
results and the amortization of acquired intangible assets. Any delays or
unexpected costs incurred in connection with the integration of acquired
operations could have a material adverse effect on the Company's business,
financial condition and results
18
of operations. There can be no assurance that the Company will be able to
implement or sustain its acquisition strategy or that its strategy will
ultimately prove profitable for the Company.
Possible Volatility of Stock Price
The Company believes certain factors, such as sales of Common Stock into
the market by existing stockholders, fluctuations in quarterly operating results
and market conditions generally, including market conditions affecting stocks of
computer hardware and software manufacturers and resellers and companies in the
Internet and electronic commerce industries in particular, and other technology
or related stocks, could cause the market price of the Common Stock to fluctuate
substantially. The stock market in general, and the stocks of computer and
software resellers, and companies in the Internet and electronic commerce
industries in particular, and other technology or related stocks, have in the
past experienced extreme price and volume fluctuations which have been unrelated
to corporate operating performance. Such market volatility may adversely affect
the market price of the Common Stock.
ITEM 2. PROPERTIES
See "Properties" in Item 1 above.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings or claims which arise
in the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to those actions will not materially affect the
Company's business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of 1999.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company has been traded on the Nasdaq National Market
since the Company's initial public offering on April 4, 1995 (the "IPO"). Prior
to the IPO, there was no public market for the Company's Common Stock. The
following table sets forth the range of high and low closing sales prices for
the Common Stock for the periods indicated, as reported by the Nasdaq National
Market.
Price Range of
Common Stock
------------------
High Low
--------- ------
Year Ended December 31, 1997
----------------------------
First Quarter............... $ 8 1/8 5
Second Quarter.............. 7 3/4 5
Third Quarter............... 13 11/16 7 1/8
Fourth Quarter.............. 16 5/16 8 1/2
Year Ended December 31, 1998
----------------------------
First Quarter............... 12 7/8 7 5/16
Second Quarter.............. 10 5 1/4
Third Quarter............... 12 1/2 6
Fourth Quarter.............. 59 11/16 5 1/4
Year Ended December 31, 1999
----------------------------
First Quarter............... 43 1/4 25 1/8
Second Quarter.............. 39 1/8 6 1/16
Third Quarter............... 7 7/8 5 1/4
Fourth Quarter.............. 11 5 3/4
On March 28, 2000, the closing price of the Company's Common Stock as
reported on the Nasdaq National Market was $11.50 per share. As of March 29,
2000, there were approximately 52 holders of record of the Common Stock.
On June 7, 1999, the Company distributed to its stockholders all of the 7.3
million shares of common stock of uBid, Inc. owned by the Company, representing
approximately 80.1% of the outstanding stock of uBid. Each of the holders of
the Company's common stock entitled to the distribution received approximately
.70488 shares of uBid common stock for each share of the Company's common stock
held by such stockholders on May 24, 1999. On June 8, 1999, the Company's
Common Stock traded ex-dividend to reflect the spin-off of uBid, and its closing
price on the Nasdaq National Market on that date was $8.6875.
The Company has never paid and has no present plans to pay any cash dividends
on its capital stock. The Company intends to retain its earnings to finance the
growth and development of its business.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data are qualified by reference
to, and should be read in conjunction with, the Company's Consolidated Financial
Statements and the notes thereto, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained elsewhere herein. The
selected income statement data for the years ended December 31, 1997, 1998 and
1999 and the selected balance sheet data as of December 31, 1998 and 1999 are
derived from the Company's audited consolidated financial statements which are
included elsewhere herein. The selected income statement data for the years
ended December 31, 1995 and 1996 along with the balance sheet data as
20
of December 31, 1995, 1996 and 1997 are derived from the audited consolidated
financial statements of the Company which are not included herein. The selected
operating data are derived from the operating records of the Company and have
not been audited.
Year Ended December 31,
---------------------------------------------------------------------------
(in thousands, except per share data)
1995 1996 1997(1) 1998(1) 1999(1)
-------- -------- -------- -------- --------
Net sales..................................... $420,877 $444,971 $546,122 $642,006 $731,955
Cost of goods sold............................ 361,803 395,000 476,053 568,309 652,404
Retail store closure inventory reserve........ - - - 3,679 -
-------- -------- -------- -------- --------
Gross profit.................................. 59,074 49,971 70,069 70,018 79,551
Selling, general and administrative expenses.. 49,844 60,585 63,252 76,812 83,687
Expenses related to retail store closure...... - - - 6,773 -
-------- -------- -------- -------- --------
Income (loss) from operations................. 9,230 (10,614) 6,817 (13,567) (4,136)
Interest income (expense)..................... 371 593 144 (291) 245
-------- -------- -------- -------- --------
Income (loss) before income taxes............. 9,601 (10,021) 6,961 (13,858) (3,891)
Income taxes (benefit)........................ 3,754 (3,972) 2,642 (5,034) 812
-------- -------- -------- -------- --------
Income (loss) from continuing operations...... 5,847 (6,049) 4,319 (8,824) (4,703)
Discontinued operations....................... - - (194) (8,971) (6,240)
-------- -------- -------- -------- --------
Net income (loss)............................. $ 5,847 $ (6,049) $ 4,125 $(17,795) $(10,943)
======== ======== ======== ======== ========
Basic earnings (loss) per share (2)
Continuing operations....................... $ 0.71 $ (0.62) $ 0.44 $ (0.87) $ (0.45)
Discontinued operations..................... - - (0.02) (0.88) (0.60)
-------- -------- -------- -------- --------
$ 0.71 $ (0.62) $ 0.42 $ (1.75) $ (1.05)
======== ======== ======== ======== ========
Diluted earnings (loss) per share (2)
Continuing operations....................... $ 0.66 $ (0.62) $ 0.43 $ (0.87) $ (0.45)
Discontinued operations..................... - - (0.02) (0.88) (0.60)
-------- -------- -------- -------- --------
$ 0.66 $ (0.62) $ 0.41 $ (1.75) $ (1.05)
======== ======== ======== ======== ========
Basic weighted average number of shares
outstanding (2)............................. 8,291 9,767 9,895 10,176 10,383
======== ======== ======== ======== ========
Diluted weighted average number of shares
outstanding (2)............................. 8,890 9,767 10,030 10,176 10,383
======== ======== ======== ======== ========
(1) Operating results in 1997, 1998 and 1999 reflect the effects of
acquisitions of ComputAbility, Ltd., and Elek-Tek, Inc. in August 1997 and
October 1997, respectively. Further, these results also reflect uBid's
results as discontinued operations. See Note 6 and Note 9 of Notes to
Consolidated Financial Statements.
(2) Earnings (loss) per share and weighted average shares outstanding have been
restated for all periods prior to 1998 to reflect the adoption of SFAS 128,
"Earnings per Share." See Note 1 of Notes to Consolidated Financial
Statements.
21
Year Ended December 31,
---------------------------------------------------------
(in thousands, except average order size)
Selected Operating Data 1995 1996 1997 1998 1999
--------- --------- --------- --------- ---------
Mail order/catalog net sales............... $353,324 $383,864 $462,705 $562,284 $558,235
Internet sales............................. $ - $ 3,239 $ 15,586 $ 36,143 $138,986
Retail net sales........................... $ 67,553 $ 57,868 $ 67,831 $ 43,579 $ 34,734
Number of catalogs distributed............. 38,680 48,753 62,220 69,427 58,955
Orders filled (mail order/catalog)......... 784 921 982 1,075 874
Orders filled (Internet)................... - 10 44 121 336
Average order size (mail order/catalog).... $ 451 $ 417 $ 471 $ 523 $ 639
Average order size (Internet).............. $ - $ 324 $ 354 $ 299 $ 414
Mailing list size.......................... 1,300 2,518 4,177 4,792 5,459
December 31,
--------------------------------------------------------
(in thousands)
Balance Sheet Data 1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Working capital............................ $ 46,307 $ 42,600 $ 30,183 $ 36,285 $ 18,697
Total assets............................... $112,569 $113,431 $131,466 $143,174 $151,533
Short-term debt............................ $ 281 $ 283 $ 10,186 $ 122 $ 148
Long-term debt, excluding current portion.. $ 589 $ 325 $ 496 $ 161 $ 284
Stockholders' equity....................... $ 56,560 $ 52,805 $ 60,082 $ 67,564 $ 48,598
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere herein.
Overview
The Company began operations in May 1987 as a mail-order company and opened
its first retail computer showroom in August 1987. After opening its first
retail showroom, the Company conducted mail order operations from one of its
retail showroom locations. The Company became an authorized Apple dealer in
1991. During 1997, the Company operated four retail showrooms in Southern
California under the name Creative Computers and three retail showrooms in
Illinois and one retail showroom in Indiana under the name of Elek-Tek. During
the first quarter of 1998, the Company closed all but one of its retail
showrooms.
During 1999, the Company successfully completed a spin-off of its former
subsidiary, uBid, Inc., to the Company's stockholders. Consistent with its
strategic focus on the Internet and business-to-business markets, the Company
formed a new subsidiary, eCOST.com, a multi-category Internet retail web site,
in February 1999. In December 1999, the Company formed a new subsidiary,
eLinux.com, to provide products, news, discussion groups, services and support
to the Linux community.
During 1997, the Company completed two acquisitions. On August 29, 1997,
the Company acquired the assets and assumed the liabilities of Milwaukee-based
ComputAbility Ltd., a privately owned direct reseller of PC/WINTEL hardware,
peripheral and software products, for $8.0 million. On October 15, 1997, the
Company acquired substantially all the assets of Elek-Tek, Inc., a marketer of
PC/WINTEL hardware, peripheral and software products located in the Midwest for
$29.4 million plus direct costs of the acquisition.
22
In the fourth quarter of 1993, the Company shifted its principal
distribution and marketing focus from retail showrooms to direct mail marketing
distribution and relocated its mail order/catalog operations to a central
location. In March 1994, the Company received authorization from Apple to offer
the full retail line of Apple products via direct mail and the Company
distributed the first edition of its MacMall catalog in April 1994. During 1997,
1998, and 1999, the Company distributed fourteen editions of its MacMall catalog
per year with total MacMall circulation of approximately 36.0 million, 33.0
million, and 31.5 million, respectively. Total MacMall circulation decreased as
the Company began to expand into the business-to-business and Internet channels.
In May 1995, the Company distributed its first PC Mall catalog focusing on
the WINTEL personal computer market. During 1997, 1998, and 1999, the Company
distributed fourteen editions of its PC Mall catalogs per year with a total
circulation of 21.9 million, 25.8 million and 21.2 million, respectively.
In September 1997, the Company distributed its first ComputAbility catalog.
During 1997, the Company distributed three ComputAbility catalogs to
approximately 1.5 million previous and prospective customers. In 1998, total
ComputAbility circulation was 9.1 million with thirteen editions. In 1999, the
Company distributed thirteen Computability catalogs with a distribution of 6.3
million.
All catalogs feature new products and contain detailed information about
product capabilities, specifications, key features and system requirements.
Net sales from mail order/catalog operations, as a percentage of net sales,
were 84.7%, 87.6% and 76.3% in 1997, 1998 and 1999, respectively, with average
order size being $471, $523 and $639 for those respective years. Net sales from
the Internet, as a percentage of net sales, were 2.9%, 5.6% and 19.0% in 1997,
1998 and 1999, respectively, with average order size of $354, $299 and $414 for
those respective years.
Net sales of the Company are derived primarily from the sale of personal
computer hardware, software, peripherals, accessories and consumer electronics
to individual consumers, home offices, small businesses and large corporations
through direct response catalogs, dedicated inbound and outbound telemarketing
sales executives, a direct sales force, retail showrooms and its Internet web
sites. Gross profit consists of net sales less product and shipping costs. The
Company receives marketing development funds ("MDF") from manufacturers of
products included in the Company's catalogs, as well as co-operative advertising
funds ("Co-Op") on products purchased from manufacturers and vendors.
A substantial portion of the Company's business is dependent on sales of
Apple computers and software and peripheral products used with Apple computers.
Products manufactured by Apple represented approximately 21.4%, 20.0% and 25.4%
of the Company's net sales in 1997, 1998 and 1999, respectively.
Results of Operations
The following table sets forth for the years indicated information derived
from the Company's consolidated statement of operations expressed as a
percentage of net sales. Results for the years ended 1997 and 1998 have been
restated to reflect the results of uBid as discontinued operations. There can be
no assurance that trends in sales growth or operating results will continue in
the future.
23
Percentage of Net Sales
--------------------------
Year Ended December 31,
--------------------------
1997 1998 1999
------- ------- ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 87.2 89.1 89.1
----- ----- -----
Gross profit 12.8 10.9 10.9
Selling, general and administrative expenses 11.6 12.0 11.4
Expenses related to retail store closure --- 1.0 ---
----- ----- -----
Income (loss) from operations 1.2 (2.1) (0.5)
Interest (income) expense, net --- 0.1 ---
----- ----- -----
Income (loss) before income taxes 1.2 (2.2) (0.5)
Income taxes (benefit) 0.4 (0.8) 0.1
----- ----- -----
Income (loss) from continuing operations 0.8 (1.4) (0.6)
Loss from discontinued operations --- (1.4) (0.9)
----- ----- -----
Net income (loss) 0.8% (2.8)% (1.5)%
===== ===== =====
Year Ended December 31, 1999 Compared to the Year Ended December 31, 1998
Net sales for the year ended December 31, 1999 were $732.0 million, an
increase of $90.0 million or 14.0% over net sales for the year ended December
31, 1998 of $642.0 million. Mail order/catalog sales for 1999 were $558.2
million, a decrease of $4.1 million or 0.7% compared to 1998 mail order/catalog
sales of $562.3 million. The decrease in mail order/catalog sales is primarily
due to a decline in circulation resulting from a shift in marketing expenditures
toward the Internet, offset by an increase in average order value. Net catalog
circulation in 1999 decreased 15.1%, or 10.5 million catalogs to 59.0 million,
of which MacMall comprised 31.5 million, PC Mall 21.2 million and ComputAbility
6.3 million. The DataCom Mall catalog was discontinued at the end of 1998.
Internet sales in 1999 were $139.0 million, an increase of 284.5%, or $102.9
million over 1998. Retail net sales in 1999 were $34.7 million, a decrease of
20.3%, or $8.9 million from 1998. WINTEL net sales increased 8.1% to $381.4
million in 1999, versus $352.9 million in 1998.
Gross profit for the year ended December 31, 1999 was $79.6 million, an
increase of $9.6 million or 13.6% from gross profit of $70.0 million for the
year ended December 31, 1998. The increase in gross profit was primarily due to
the increase in sales in 1999 over 1998. Gross profit as a percentage of sales
was 10.9% in 1999, flat versus 1998. The gross profit percentage was negatively
affected by lower margins experienced by eCOST.com and other factors, including
outbound sales initiatives and fluctuations in key vendor support programs,
offset by the impact of the 1998 write-offs.
Selling, general and administrative expenses (SG&A) were $83.7 million for
the year ended December 31, 1999, an increase of $6.9 million or 9.0% over SG&A
expenses of $76.8 million for the year ended December 31, 1998. As a percentage
of net sales, SG&A expenses were 11.4% in 1999, versus 12.0% in 1998. The
decrease is primarily the result of first quarter write-offs included in the
prior year related to a more rapid decline in Mac sales and the effect of rapid
price erosion at that time.
Net interest income was $0.2 million for the year ended December 31, 1999
compared to $0.3 million net interest expense for the year ended December 31,
1998. The change primarily resulted from the elimination of interest expense
related to the 1997 borrowings to finance the acquisition of Elek-Tek.
Income tax provision for the year ended December 31, 1999 was $0.8 million
versus a benefit of $5.0 million for the year ended December 31, 1998. The
effective tax rate for 1999 increased to 20.8% from (36.3%) in 1998. The change
in effective tax rate is primarily due to the provision of valuation allowance
against deferred tax assets.
During 1997, the Company operated four retail showrooms in Southern
California under the name Creative Computers and three retail showrooms in
Illinois and one retail showroom in Indiana under the name of Elek-Tek. During
February 1998, the Company closed its Indiana showroom. On March 20, 1998, the
Company closed six of its other retail showrooms to focus its efforts on its
catalog, corporate and Internet channels. Net sales from the Company's retail
showroom operations were $67.8 million and $43.6
24
million for the years ended December 31, 1997 and 1998, representing 12.4% and
6.8% of net sales, respectively. In the first quarter of 1998, the Company
recorded a one-time pretax restructuring charge of $10.5 million relating to
exit costs associated with the closing of retail operations. Recorded in
selling, general and administrative costs were a $3.1 million write-off of
goodwill, a $1.9 million write-off for fixed assets, a $1.5 million reserve for
lease exit cost, and $0.3 million employee-related severance costs. Recorded as
cost of sales were $3.7 million of reserves for store inventory. The reserves
have been fully utilized as of December 31, 1998. In addition, during the first
quarter of 1998, $7.0 million of pretax write-offs were taken primarily relating
to a more rapid decline in Mac sales during the quarter and the effects of rapid
price erosion and other changes in the industry on inventory and receivables
during the quarter.
As a result of the spin-off of uBid in June 1999, the Company recorded uBid's
results of operations in discontinued operations for 1999, 1998 and 1997.
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Net sales for the year ended December 31, 1998 were $642.0 million, an
increase of $95.9 million or 18% over net sales for the year ended December 31,
1997 of $546.1 million. Mail order/catalog sales for 1998 were $562.3 million,
an increase of $99.6 million or 21.5% over 1997 mail order/catalog sales of
$462.7 million. The increase in direct marketing sales was primarily due to an
increase in WINTEL sales, partially offset by a decrease in Mac sales. Catalog
circulation in 1998 increased 11.6% to 69.4 million catalogs, of which MacMall
comprised 33.1 million, PC Mall 25.8 million, ComputAbility 9.1 million and
DataCom Mall 1.4 million. Internet sales were $36.1 million in 1998, an
increase of 131.9% or $20.6 million over 1997. Retail net sales in 1998 were
$43.6 million, a decrease of $24.3 million or 35.8% due to the closure of seven
of the Company's stores in the first quarter of 1998. WINTEL net sales
increased 64.8% to $364.6 million in 1998, versus $221.3 million in 1997.
Gross profit for the year ended December 31, 1998 was $70.0 million, a
decrease of $0.1 million from gross profit of $70.1 million for the year ended
December 31, 1997. The change in gross profit was primarily due to the increase
in sales in 1998 over 1997, offset by the large first quarter write-off related
to the retail store closures and slow-moving and excess inventory. Gross profit
as a percentage of sales was 10.9% in 1998, versus 12.8% in 1997. The decrease
in gross profit percentage was primarily due to the 1998 first quarter write-
offs.
Selling, general and administrative expenses (SG&A) were $76.8 million for
the year ended December 31, 1998, an increase of $13.5 million or 21% over SG&A
expenses of $63.3 million for the year ended December 31, 1997. As a percentage
of net sales, SG&A expenses were 12.0% in 1998, versus 11.6% in 1997. The
increase is primarily due to the first quarter write-offs related to a more
rapid decline in Mac sales and the effect of rapid price erosion and other
charges related to the store closures in the first quarter of 1998.
Net interest expense was $0.3 million for the year ended December 31, 1998
compared with $0.1 million net interest income for the year ended December 31,
1997. The increase is primarily attributed to borrowings in conjunction with
the acquisition of Elek-Tek.
Income tax benefit for the year ended December 31, 1998 was $5.0 million
versus a provision of $2.6 million for the year ended December 31, 1997. The
effective tax rate for 1998 decreased to (36.3%) from 38.0% in 1997. The
decrease in effective tax rate is primarily due to the loss recorded in 1998.
Liquidity and Capital Resources
The Company's primary capital need has been funding the working capital
requirements created by its rapid growth in sales. Historically, the Company's
primary sources of financing have come from public offerings and borrowings from
its stockholders, private investors and financial institutions. In April and
August 1995, the Company completed an initial public offering and a follow-on
offering of its Common Stock which resulted in aggregate net proceeds to the
Company of approximately $46.6 million. Cash flows from operations were $18.4
million, $13.7 million and $21.5 million for 1997, 1998 and 1999, respectively.
25
Cash flows from operations in 1999 were favorable due to continuing improvements
of inventory and payables management.
Inventory decreased $1.1 million in 1999 and inventory turns continued to
improve from 13.5 in 1998 to 16.4 in 1999. Accounts receivable increased $7.2
million during 1999, primarily due to higher open account business-to-business
sales.
During the year ended December 31, 1999, the Company's capital expenditures
were $4.2 million as compared to $3.2 million in 1998 and $2.9 million in 1997.
The Company's primary capital needs will continue to be funding its working
capital requirements for anticipated sales growth, possible acquisitions and new
business ventures.
As of December 31, 1999 and 1998, the Company had advances outstanding of
$12.4 million and $38.0 million, respectively, under a $60.0 million line of
credit with a finance company. The line of credit allows working capital
advances up to $27.5 million and floorplan inventory financing up to $45.0
million; however, aggregate advances and floorplan financing cannot exceed $60.0
million. The advances outstanding at December 31, 1999 and 1998 relate to
floorplan inventory financing to purchase inventory, which is included in
accounts payable. There were no outstanding working capital advances at
December 31, 1999 or 1998. Working capital advances are also limited to
eligible accounts receivable and inventory collateral. The line of credit is
secured by substantially all of the Company's assets and is cancelable upon 90
days' advance notice. Interest for amounts owed for working capital advances
are calculated at the finance company's prime rate (8.50% and 7.75% per annum at
December 31, 1999 and 1998, respectively). Floorplan financing does not bear
interest if paid within an average of 30 days of the inventory purchase date.
Interest on floorplan financing not paid within an average of 45 days is charged
at the finance company's prime rate plus 2% (10.50% and 9.75% per annum at
December 31, 1999 and 1998, respectively). The line of credit requires that the
Company maintain a minimum tangible net worth, a minimum pretax earnings to
interest expense ratio and limits debt as a ratio to tangible net worth. At
December 31, 1999 and 1998, the Company was in compliance with these covenants.
At December 31, 1999 and 1998, the Company had $47.6 million and $22.0 million
available for working capital advances and floorplan inventory financing.
At December 31, 1999 and 1998, the Company had cash and short-term
investments of $24.3 million and $6.4 million, respectively, and working capital
of $18.7 million and $36.3 million, respectively. The Company believes that
current working capital, together with cash flows from operations and available
lines of credit, will be adequate to support the Company's current operating
plans through 2000. However, if the Company needs extra funds, such as for
acquisitions or expansion or to fund a significant downturn in sales that causes
losses, there are no assurances that adequate financing will be available at
acceptable terms, if at all.
In July 1996, the Company announced its plan to repurchase up to 1,000,000
shares of its Common Stock. The shares will be repurchased from time to time at
prevailing market prices, through open market or negotiated transactions,
depending upon market conditions. No limit was placed on the duration of the
repurchase program. There is no guarantee as to the exact number of shares that
the Company will repurchase. Subject to applicable securities laws, repurchases
may be made at such times and in such amounts as the Company's management deems
appropriate. The program can also be discontinued at any time management feels
additional purchases are not warranted. The Company will finance the repurchase
plan with existing working capital. As of December 31, 1999, the Company has
repurchased 15,000 shares.
As part of its growth strategy, the Company may, in the future, acquire other
companies in the same or complementary lines of business, and pursue other
business ventures. Any launch of a new business venture or any acquisition and
the ensuing integration of the operations of the acquired company with those of
the Company would place additional demands on the Company's management,
operating and financial resources. The Company currently has no definitive
agreements with respect to any acquisitions.
26
Year 2000
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data during the year 2000 or
thereafter. The problem affects those systems or products that are programmed
to accept a two-digit code in date code fields. To correctly identify dates
after December 31, 1999, a four-digit date code field must be created to be what
is commonly termed "year 2000 compliant."
In prior reports, the Company has discussed the nature and progress of its
plans to become year 2000 ready. In late 1999, the Company completed its
testing and remediation of systems. As a result of those planning and
implementation efforts, the Company experienced no significant disruptions in
mission critical information technology and non-information technology systems,
and the Company believes those systems successfully responded to the year 2000
date change. The Company expensed approximately $0.5 million during 1999 in
connection with its testing and remediation efforts. The Company is not aware
of any material problems resulting from year 2000 issues, either with its
products, its internal systems, or the products and services of third parties.
Although the Company has not experienced any material year 2000 problems or
disruptions since January 1, 2000, there can be no assurance that such problems
or disruptions will not occur in the future. The Company will continue to
monitor its mission critical computer applications and those of its suppliers
and vendors throughout the year 2000 to ensure that any latent year 2000 matters
that may arise are addressed promptly.
Inflation
Inflation has not had a material impact upon operating results, and the
Company does not expect it to have such an impact in the near future. There can
be no assurances, however, that the Company's business will not be so affected
by inflation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and long-term debt. At
March 30, 2000, the carrying values of the Company's financial instruments
approximated their fair values based on current market prices and rates.
It is the Company's policy not to enter into derivative financial
instruments. The Company does not have any significant foreign currency
exposure since it does not transact business in foreign currencies. Therefore,
the Company does not have significant overall currency exposure at March 30,
2000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements listed in Item 14(a) under the caption "Consolidated Financial
Statements" and commencing on page F-1 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of the Company is set forth under the caption
"Election of Directors," in the Company's definitive Proxy Statement to be filed
in connection with its 2000 Annual Meeting of Stockholders and such information
is incorporated herein by reference. A list of executive officers of Registrant
is included in Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption
"Executive Compensation and Other Information" and "Election of Directors -
Compensation of Directors" in the Company's definitive Proxy Statement to be
filed in connection with its 2000 Annual Meeting of Stockholders and such
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's definitive Proxy Statement to be filed in connection with its 2000
Annual Meeting of Stockholders and such information is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the captions
"Executive Compensation and Other Information -- Certain Relationships and
Related Transactions and Compensation Committee Interlocks and Insider
Participation" in the Company's definitive Proxy Statement to be filed in
connection with its 2000 Annual Meeting of Stockholders and such information is
incorporated herein by reference.
28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following consolidated financial statements of Registrant are filed as part
of this report:
(a) (1) Consolidated Financial Statements. See Index to Consolidated
Financial Statements.
(2) Financial Statement Schedules. See Index to Consolidated Financial
Statements.
(3) Exhibits.
The following exhibits are filed or incorporated by reference as
part of this report:
Exhibit Number Description
-------------- -----------
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
10.1* 1994 Stock Incentive Plan and form of stock option agreement
(1)
10.2* Employment Agreement dated January 1, 1995, between Creative
Computers, Inc. and Frank F. Khulusi (1)
10.4* Employment Agreement dated January 1, 1994, between Creative
Computers, Inc. and Dan DeVries (1)
10.5 Standard Industrial/Commercial Single-Tenant Lease-Net dated
February 10, 1993 between Herman Platt and Marjorie Platt, as Co-
Trustees of the Herman Platt and Marjorie Platt Trust dated
October 11, 1985 and Creative Computers, Inc. for the premises
located at 2645 Maricopa Street, Torrance, California (2)
10.6 ITT Commercial Financial Corporation ("ITT") financing
arrangements:
a. Agreement for Wholesale Financing (Security Agreement-
Arbitration) dated April 4, 1991, as amended, between ITT
and Creative Computers, Inc. (1)
10.18* Directors' Non-Qualified Stock Option Plan, amended and
restated as of May 18, 1999 (7)
10.22 Agreement dated August 1, 1995 between Creative Computers, Inc.
and Deutsche Financial Services (formerly known as ITT Commercial
Finance Corp.) (2)
10.25 Industrial Lease Agreement between Corporate Estates, Inc. and
Creative Computers, Inc. dated September 15, 1995 for the
premises located at 4515 E. Shelby Drive, Memphis, Tennessee,
filed in connection with the Company's 10-Q for the quarter ended
September 30, 1995 (4)
10.28 Authorized Apple Dealer U.S. Sales Agreement dated August 29,
1996; Authorized Apple Catalog Reseller Sales Agreement dated
August 29, 1996; Dealer Apple Authorized Service Provider
Agreement dated August 29, 1996; Apple Corporate Alliance Program
Addendum to the Authorized Apple Dealer Sales Agreement dated
August 29, 1996 (4)
10.29 Amendment to Agreement for Wholesale Financing dated February
25, 1997 (4)
10.30 Asset Purchase Agreement dated September 27, 1997 between
Creative Computers, Inc. and Elek-Tek (3)
10.31 Business Credit and Security Agreement dated October 14, 1997
between Deutsche Financial Service Corporation and Elek-Tek
Acquisition Corp. (3)
10.32 Business Credit and Security Agreement dated October 14, 1997
between Deutsche Financial Service Corporation and Creative
Computers, Inc. (3)
10.33 Asset Purchase Agreement dated August 29, 1997 between Creative
Computers, Inc. and ComputAbility, Ltd. (5)
10.34 Registration Rights Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of December 7, 1998 (6)
29
10.35 Separation and Distribution Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of December 7, 1998, as
amended (7)
10.36 Services Agreement by and between Creative Computers, Inc. and
uBid, Inc., dated as of December 7, 1998 (6)
10.37(A) Tax Indemnification and Allocation Agreement by and between
Creative Computers, Inc. and uBid, Inc., dated as of December 7,
1998, as amended (8)
10.37(B) Amendment No. 1 to the Tax Indemnification and Allocation Agreement
by and among uBid, Creative Computers and CMGI, Inc., dated as of
February 9, 2000 (10)
10.38 Sublease Agreement between Creative Computers, Inc. and uBid,
Inc., dated as of July 1, 1998 (6)
10.39 Agreement Restricting Transfer of Assets and Letter Agreement
dated as of September 23, 1998 by and between Deutsche Financial
Services Corporation and Creative Computers, Inc. and uBid, Inc.
(6)
10.40 Assignment and License Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of November 30, 1998 (6)
10.41 Sublease Agreement between Creative Computers, Inc. and uBid, Inc.,
dated as of December 1, 1999
10.42* Employment Agreement dated July 22, 1999, between Creative
Computers, Inc. and Scott Klein (9)
21.1 Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule (filed with EDGAR version only)
(1) Incorporated by reference to the Company's Registration Statement
on Form S-1 (33-89572) declared effective on April 4, 1995.
(2) Incorporated by reference to the Company's Registration Statement
on Form S-1 (33-95416) declared effective on August 23, 1995.
(3) Incorporated by reference to the Company's Form 8-K dated October
11, 1997, filed with the Commission on October 30, 1997
(4) Incorporated by reference to the Company's 1996 Form 10-K, filed
with the Commission on March 31, 1997.
(5) Incorporated by reference to the Company's 1997 Form 10-K, filed
with the Commission on March 31, 1998.
(6) Incorporated by reference to the Registration Statement on Form
S-1 of uBid, Inc. (File No. 333-58477), on file with the
Commission.
(7) Incorporated by reference to the Company's Report on Form 10-Q
for the quarter ended June 30, 1999, filed with the Commission on
August 16, 1999.
(8) Incorporated by reference to the Company's Report on Form 10-Q
for the quarter ended March 31, 1999, filed with the Commission
on May 17, 1999.
(9) Incorporated by reference to the Company's Report on Form 10-Q
for the quarter ended September 30, 1999, filed with the
Commission on November 15, 1999.
(10) Incorporated by reference to the Annual Report on 10-K of uBid,
Inc. (Commission File No. 000-25119) for the year ended December
31, 1999.
* The referenced exhibit is a compensatory contract, plan or arrangement.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the fourth quarter of the
period covered by this Report.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Torrance,
State of California, on March 30, 2000.
CREATIVE COMPUTERS, INC.
By: /s/ FRANK F. KHULUSI
------------------------------
Frank F. Khulusi
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Frank F. Khulusi and Theodore R. Sanders,
and each of them, as his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Report
on Form 10-K, and to file the same, with exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in connection therewith, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ FRANK F. KHULUSI Chairman of the Board of March 30, 2000
- --------------------------- Directors and Chief
Frank F. Khulusi Executive Officer
(Principal Executive Officer)
/s/ THEODORE R. SANDERS Chief Financial Officer March 30, 2000
- --------------------------- (Principal Financial and
Theodore R. Sanders Accounting Officer)
/s/ SAM U. KHULUSI Director March 30, 2000
- ---------------------------
Sam U. Khulusi
/s/ THOMAS MALOOF Director March 30, 2000
- ---------------------------
Thomas Maloof
/s/ RONALD B. RECK Director March 30, 2000
- ---------------------------
Ronald B. Reck
31
CREATIVE COMPUTERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements and Supplementary Data
- -------------------------------------------
Report of Independent Accountants...................................................................... F-2
Consolidated Balance Sheet at December 31, 1999 and 1998............................................... F-3
Consolidated Statement of Operations for the Years Ended December 31, 1999, 1998 and 1997.............. F-4
Consolidated Statement of Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997.... F-5
Consolidated Statement of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997.............. F-6
Notes to Consolidated Financial Statements............................................................. F-7
Quarterly Financial Information (unaudited)............................................................ F-18
Financial Statement Schedule
- ----------------------------
Schedule II - Valuation and Qualifying Accounts........................................................ F-19
All other schedules are omitted since the required information is not present or is not present in amounts
sufficient to require submission of the schedule, or because the information required is included in the
consolidated financial statements and notes thereto.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Creative Computers, Inc.
In our opinion, based upon our audits and the report of other auditors, the
consolidated financial statements listed in the accompanying index present
fairly, in all material respects, the financial position of Creative Computers,
Inc. and its subsidiaries at December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. In addition, in our opinion, the financial
statement schedule listed in the accompanying index presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We did not
audit the financial statements of uBid, Inc., a former majority-owned
subsidiary, for the year ended December 31, 1998, which statements reflect total
assets of $34,625,000 and total liabilities of $15,992,000 at December 31, 1998,
and total revenues of $48,232,000 and net loss of $10,169,000 for the year then
ended. Those statements were audited by other auditors whose report thereon has
been furnished to us, and our opinion expressed herein, insofar as it relates to
the amounts included for uBid, Inc. at December 31, 1998 and for the year then
ended, is based solely on the report of the other auditors. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits and the report of other auditors provide a reasonable
basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
February 4, 2000
F-2
CREATIVE COMPUTERS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
December 31,
---------------------
ASSETS 1999 1998
--------- ---------
Current assets:
Cash and cash equivalents $ 24,326 $ 6,442
Accounts receivable, net of allowance for doubtful
accounts of $1,483 and $3,676 47,618 40,429
Inventories 38,068 39,158
Prepaid expenses and other current assets 5,781 5,374
Net assets of uBid discontinued segment, net of
minority interest of $3,708 in 1998 - 14,925
Income tax refund receivable 177 190
Notes receivable 3,331 -
Deferred income taxes 2,047 5,216
-------- --------
Total current assets 121,348 111,734
Notes receivable - 3,331
Property, plant and equipment, net 14,569 14,391
Goodwill, net 11,836 12,318
Deferred income taxes 3,738 1,262
Other assets 42 138
-------- --------
$151,533 $143,174
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 86,609 $ 62,129
Accrued expenses and other current liabilities 15,894 13,198
Capital leases - current portion 142 116
Notes payable - current portion 6 6
-------- --------
Total current liabilities 102,651 75,449
Capital leases 136 6
Notes payable 148 155
-------- --------
Total liabilities 102,935 75,610
-------- --------
Commitments and contingencies (Note 5)
Stockholders' equity:
Common stock, $.001 par value; 15,000,000 shares
authorized; 10,404,069 and 10,264,539 shares issued 11 10
Preferred stock, $.001 par value; 5,000,000 shares
authorized; none issued and outstanding - -
Additional paid-in capital 74,337 82,361
Treasury stock, at cost: 15,000 shares (91) (91)
Retained earnings (accumulated deficit) (25,659) (14,716)
-------- --------
Total stockholders' equity 48,598 67,564
-------- --------
$151,533 $143,174
======== ========
See accompanying notes to consolidated financial statements.
F-3
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
Year ended December 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
Net sales $731,955 $642,006 $546,122
Cost of goods sold 652,404 568,309 476,053
Retail store closure inventory reserve - 3,679 -
-------- -------- --------
Gross profit 79,551 70,018 70,069
Selling, general and administrative
expenses 83,687 76,812 63,252
Expenses related to retail store closures - 6,773 -
-------- -------- --------
Income (loss) from operations (4,136) (13,567) 6,817
Interest income (expense), net 245 (291) 144
-------- -------- --------
Income (loss) before income taxes (3,891) (13,858) 6,961
Income tax provision (benefit) 812 (5,034) 2,642
-------- -------- --------
Income (loss) from continuing
operations (4,703) (8,824) 4,319
Loss from discontinued operations,
net of minority interest of $1,500
and $1,198 in 1999 and 1998 (6,240) (8,971) (194)
-------- -------- --------
Net income (loss) $(10,943) $(17,795) $ 4,125
======== ======== ========
Basic earnings (loss) per share
Continuing operations $ (0.45) $ (0.87) $ 0.44
Discontinued operations (0.60) (0.88) (0.02)
-------- -------- --------
$ (1.05) $ (1.75) $ 0.42
======== ======== ========
Diluted earnings (loss) per share
Continuing operations $ (0.45) $ (0.87) $ 0.43
Discontinued operations (0.60) (0.88) (0.02)
-------- -------- --------
$ (1.05) $ (1.75) $ 0.41
======== ======== ========
Basic weighted average number of shares
outstanding 10,383 10,176 9,895
======== ======== ========
Diluted weighted average number of shares
outstanding 10,383 10,176 10,030
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Additional Retained
-------------- Paid-in Earnings Treasury
Shares Amount Capital (Deficit) Stock Total
------ ------ ------- --------- ------ -----
Balance at December 31, 1996 9,792 $10 $53,932 $ (1,046) $(91) $ 52,805
Issuance of stock in connection
with acquisition 272 2,500 2,500
Stock option exercises, including
related income tax benefit 41 340 340
Net income 4,125 4,125
------ --- ------- --------- ---- --------
Balance at December 31, 1997 10,105 10 56,772 3,079 (91) 59,770
Capital contributed by minority
stockholders of subsidiary 18,943 18,943
uBid stock-based compensation 5,267 5,267
Stock option exercises, including
related income tax benefit 160 1,379 1,379
Net loss (17,795) (17,795)
------ --- ------- --------- ---- --------
Balance at December 31, 1998 10,265 10 82,361 (14,716) (91) 67,564
Spin-off of uBid subsidiary (8,877) (8,877)
Stock option exercises 139 1 853 854
Net loss (10,943) (10,943)
------ --- ------- --------- ---- --------
Balance at December 31, 1999 10,404 $11 $74,337 $(25,659) $(91) $ 48,598
====== === ======= ======== ==== ========
See accompanying notes to consolidated financial statements.
F-5
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Year ended December 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $(10,943) $(17,795) $ 4,125
-------- -------- --------
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,961 3,882 2,333
Provision (benefit) for deferred income taxes 693 (5,017) 2,469
Loss on disposal of property, plant and equipment - 1,950 783
Loss on impairment of goodwill - 3,095 -
Loss from discontinued operations 6,240 8,971 194
Changes in assets and liabilities, net of acquisitions
and spin-off:
Accounts receivable (7,189) 2,017 (5,773)
Inventories 1,090 3,483 17,416
Prepaid expenses and other current assets (471) (2,561) 926
Other assets 96 (742) 3
Accounts payable 24,480 16,171 (6,827)
Accrued expenses and other current liabilities 2,504 (75) 1,063
Income tax refund receivable 13 279 1,723
-------- -------- --------
Total adjustments 32,417 31,453 14,310
-------- -------- --------
Net cash provided by operating activities 21,474 13,658 18,435
-------- -------- --------
Cash flows from investing activities:
Redemptions of securities available for sale - - 1,536
Purchase of securities available for sale - - (1,015)
Acquisition of Elek-Tek - - (9,083)
Acquisition of ComputAbility - - (5,482)
Acquisition of property, plant and equipment (4,185) (3,209) (2,945)
Advances to uBid - (2,661) -
Proceeds from sale of equipment - - 13
-------- -------- --------
Net cash used in investing activities (4,185) (5,870) (16,976)
-------- -------- --------
Cash flows from financing activities:
Net line of credit payments - (9,956) (10,775)
Payments under notes payable (7) (210) (81)
Principal payments of obligations under capital leases (252) (233) (254)
Proceeds from stock issued under stock option plans 854 1,035 340
-------- -------- --------
Net cash provided by (used in) financing activities 595 (9,364) (10,770)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 17,884 (1,576) (9,311)
Cash and cash equivalents:
Beginning of year 6,442 8,018 17,329
-------- -------- --------
End of year $ 24,326 $ 6,442 $ 8,018
======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
1. Summary of Significant Accounting Policies
Description of Company
Creative Computers, Inc. (the "Company"), founded in 1987, is a direct
marketer of personal computer hardware, software and peripheral products, as
well as consumer electronics. The Company offers products to individual
consumers, home offices, small businesses and large corporations through direct
response catalogs, dedicated inbound and outbound telemarketing sales
executives, a direct sales force, a retail showroom and multiple Internet web
sites. The Company offers a broad selection of products through its distinctive,
full-color catalogs, MacMall, PC Mall, PC Mall.Com, MacMall Buyers Software
Guide and ComputAbility, the Company's worldwide web sites on the Internet, and
other promotional materials.
During 1997, the Company acquired and assimilated two marketers of personal
computer hardware and software products, Elek-Tek, Inc. and ComputAbility, Ltd.
In September 1997, the Company formed a wholly owned subsidiary, uBid, Inc.
("uBid") to sell computer-related products and consumer electronics through an
auction format on the Internet. In December 1998, uBid completed an initial
public offering of 1,817,000 shares of its common stock. On June 7, 1999, the
Company divested its ownership in uBid by means of a tax-free distribution of
all of its remaining 7.3 million shares of uBid common stock to the Company's
shareholders of record as of May 24, 1999. In accordance with Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations," uBid's
revenues and expenses have been excluded from the Company's consolidated
revenues and expenses from continuing operations. The Company's share of uBid's
operating results, net of taxes, for the periods presented have been reported as
a separate line item on the Company's consolidated statement of operations under
the caption "Loss from discontinued operations." The Company's consolidated
balance sheet and consolidated statement of cash flows have also been restated
for all periods presented to reflect the divestiture of uBid. uBid's revenues
were $9 and $48,232 for the years ended December 31, 1997 and 1998,
respectively, and $64,784 for the period ended June 7, 1999.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
respective reporting periods. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions
have been eliminated.
Revenue Recognition
Net sales include product sales net of returns and allowances, and gross
outbound shipping and handling charges. The Company recognizes revenue from
product sales, net of discounts, coupon redemption and estimated sales returns,
when the products are shipped to customers. The Company provides an allowance
for sales returns, which is based on historical experience. For all product
sales shipped directly from suppliers to customers, the Company takes title to
the products sold upon shipment, bears credit risk, and bears inventory risk for
returned products that are not successfully returned to suppliers, although some
of these risks are mitigated through arrangements with the Company's shippers
and suppliers.
F-7
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Cash Equivalents
All highly liquid investments with initial maturities of three months or
less are considered cash equivalents.
Concentration of Credit Risk
Accounts receivable potentially subject the Company to credit risk. The
Company extends credit to its customers based upon an evaluation of each
customer's financial condition and credit history and generally does not require
collateral. The Company has historically incurred minimal credit losses. At
December 31, 1999 and 1998, receivables from one large customer were $6.0
million and $8.8 million, respectively.
Inventories
Inventories consist primarily of finished goods, and are stated at cost
(determined under the first-in, first-out cost method) or market, whichever is
lower. At December 31, 1999 and 1998, the Company had reserves of $2,331 and
$4,740, respectively, for demonstration inventory, lower of cost or market
pricing and potential excess and obsolete inventory.
Deferred Advertising Costs and Revenue
The Company produces and circulates catalogs at various dates throughout the
year. The Company receives market development funds and cooperative (co-op)
advertising funds from vendors included in each catalog. These funds are
recognized based on sales generated over the life of the catalog, which
approximates eight weeks. The costs of developing and circulating each catalog
are deferred and charged to advertising expense in the same time period as the
co-op funds based on sales over the life of the catalog. Advertising expense,
net of advertising revenue earned, included in selling, general and
administrative expenses, was $7,325, $4,157 and $1,387 in 1999, 1998, and 1997,
respectively. Deferred advertising costs were $4,870 and $4,684 at December 31,
1999 and 1998, respectively, and are included in prepaid expenses and other
current assets in the consolidated balance sheet.
Property, Plant and Equipment
Property, plant and equipment (including equipment acquired under capital
leases) are stated at cost and are depreciated using straight-line methods over
the estimated useful lives of the assets, as follows:
Furniture and fixtures 5-7 years
Leasehold improvements Life of lease--not to exceed 15 years
Computers, machinery and equipment 3-7 years
Building 31.5 years
F-8
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Disclosures About Fair Value of Financial Instruments
The carrying amount of cash, cash equivalents, accounts receivable,
accounts payable and accrued expenses and other current liabilities approximates
fair value because of the short-term maturity of these instruments. The carrying
amount of the Company's notes payable approximate fair value based upon the
current rates offered to the Company for obligations of similar terms and
remaining maturities.
Goodwill
Goodwill, resulting from acquisitions, is amortized using the straight-line
method over periods not exceeding twenty-five years and is subject to periodic
review for impairment. Accumulated amortization at December 31, 1999 and 1998
was $1,086 and $604, respectively. Amortization expense totaled $482, $514 and
$90 in 1999, 1998 and 1997, respectively. During 1998, in conjunction with the
store closures, the Company determined that goodwill related to acquired retail
stores was impaired and, accordingly, the Company recorded a write-off of
$3,095.
Accounting for the Impairment of Long-Lived Assets
The Company reviews long-lived assets and certain intangible assets for
impairment when events or changes in circumstances indicate the carrying amount
of an asset may not be recoverable. In the event the sum of the expected
undiscounted future cash flows resulting from the use of the asset is less than
the carrying amount of the asset, an impairment loss equal to the excess of the
asset's carrying value over its fair value is recorded.
Income Taxes
The Company accounts for income taxes under the liability method. Under
this method, deferred income taxes are recognized by applying enacted statutory
tax rates applicable to future years to differences between the tax bases and
financial reporting amounts of existing assets and liabilities. A valuation
allowance is provided when it is more likely than not that all or some portion
of deferred tax assets will not be realized.
Earnings (Loss) per Share
Basic EPS excludes dilution and is computed by dividing net income (loss)
by the weighted average number of common shares outstanding during the reported
periods. Diluted EPS reflects the potential dilution that could occur if stock
options and other commitments to issue common stock were exercised using the
treasury stock method.
F-9
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The composition of Basic and Diluted EPS is as follows:
1999 1998 1997
------------ ------------ ------------
Income (loss) from continuing operations $ (4,703) $ (8,824) $ 4,319
Loss from discontinued operations (6,240) (8,971) (194)
----------- ----------- -----------
Net income (loss) $ (10,943) $ (17,795) $ 4,125
=========== =========== ===========
Weighted average shares - Basic 10,383,052 10,175,864 9,895,179
Effect of dilutive stock options
and warrants - - 135,238
Weighted average shares - Diluted 10,383,052 10,175,864 10,030,417
Basic earnings (loss) per share
Continuing operations (0.45) (0.87) 0.44
Discontinued operations (0.60) (0.88) (.02)
----------- ----------- -----------
$ (1.05) $ (1.75) $ 0.42
=========== =========== ===========
Diluted earnings (loss) per share
Continuing operations (0.45) (0.87) 0.43
Discontinued operations (0.60) (0.88) (.02)
----------- ----------- -----------
$ (1.05) $ (1.75) $ 0.41
=========== =========== ===========
Accounting for Stock-Based Compensation
The Company accounts for employee stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25 and related interpretations. The
disclosures required by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123), have been included in
Note 7.
1. Reclassifications
Certain reclassifications have been made to the 1997 and 1998 financial
statement amounts to conform to the 1999 presentation.
2. Property, Plant and Equipment
Property, plant and equipment consist of the following as of December 31:
1999 1998
--------- --------
Furniture and fixtures $ 2,216 $ 2,370
Leasehold improvements 3,181 2,703
Computers, machinery and equipment 18,507 14,474
Building 2,827 2,827
Land 1,446 1,446
-------- -------
28,177 23,820
Less: Accumulated depreciation and amortization (13,608) (9,429)
-------- -------
$ 14,569 $14,391
======== =======
Depreciation expense in 1999, 1998 and 1997 totaled $4,415, $3,307 and $2,247,
respectively.
F-10
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
3. Line of Credit
As of December 31, 1999 and 1998, the Company had advances outstanding of
$12,362 and $37,971, respectively, under a $60,000 line of credit with a finance
company. The line of credit allows working capital advances up to $27,500 and
floorplan inventory financing up to $45,000, however, total advances and
floorplan financing cannot exceed $60,000. The advances outstanding at December
31, 1999 and 1998 relate to floorplan inventory financing to purchase inventory
which is included in accounts payable. There were no outstanding working
capital advances at December 31, 1999 or 1998. Working capital advances are
also limited to eligible accounts receivable and inventory collateral. The line
of credit is collateralized by substantially all of the Company's assets and is
cancelable upon 90 days' advance notice. Interest for amounts owed for working
capital advances are calculated at the finance company's prime rate (8.50% and
7.75% per annum at December 31, 1999 and 1998, respectively). Floorplan
financing does not bear interest if paid within an average of 30 days of the
inventory purchase date. Interest on floorplan financing not paid within an
average of 45 days is charged at the finance company's prime rate plus 2%
(10.50% and 9.75% per annum at December 31, 1999 and 1998, respectively). The
line of credit requires that the Company maintain a minimum tangible net worth,
a minimum pretax earnings to interest expense ratio and limits debt as a ratio
to tangible net worth. At December 31, 1999 and 1998, the Company was in
compliance with these covenants. At December 31, 1999 and 1998, the Company had
$47,638 and $22,029 available for working capital advances and floorplan
inventory financing.
4. Income Taxes
The provision (benefit) for income taxes consists of the following for the
years ended December 31:
1999 1998 1997
------- -------- ------
Current
Federal $ 106 $ (100) $ 103
State 13 83 70
----- ------- ------
119 (17) 173
----- ------- ------
Deferred
Federal 620 (4,584) 2,207
State 73 (433) 262
----- ------- ------
693 (5,017) 2,469
----- ------- ------
$ 812 $(5,034) $2,642
===== ======= ======
The provision (benefit) for income taxes differed from the amount computed
by applying the U.S. federal statutory rate to income (loss) before income taxes
due to the effects of the following:
1999 1998 1997
------- ------- ------
Expected taxes at federal
statutory tax rate (34.0)% (34.0)% 34.0%
State income taxes, net of federal
income tax benefit (2.9)% (1.5)% 5.0%
Change in valuation allowance 53.7% -- --
Other 4.0% (0.8)% (1.0)%
------ ------ -----
20.8% (36.3)% 38.0%
====== ====== =====
F-11
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The significant components of deferred tax assets and liabilities are as
follows at December 31:
1999 1998
-------- --------
Accounts receivable $ 638 $ 1,439
Inventories 356 786
Property, plant and equipment (162) (1,194)
Amortization (462) (394)
Accrued expenses and reserves 621 606
Tax credits and loss carryforwards 8,171 5,232
Other 3 3
Less: Valuation allowance (3,380) 0
------- -------
Net deferred tax assets $ 5,785 $ 6,478
======= =======
At December 31, 1999, the Company had federal net operating loss
carryforwards of $22,046, which expire between 2018 and 2019. At December 31,
1999, the Company had various state net operating loss carryforwards ranging in
amounts from $53 to $4,792, which expire between 2003 and 2004. At December 31,
1999, the Company also had federal and state capital loss carryforwards of $71,
which expire between 2000 and 2001.
5. Commitments and Contingencies
Leases
The Company occupies office and warehouse space under various operating
leases which provide for minimum annual rentals and escalations based on
increases in real estate taxes and other operating expenses.
Minimum annual rentals at December 31, 1999 were as follows:
2000 $2,530
2001 2,502
2002 1,882
2003 273
2004 207
Thereafter 13
------
Total $7,407
======
In 1999, 1998 and 1997 rent expense included in selling, general and
administrative costs was $3,206, $2,486 and $1,978, respectively. Some of the
leases contain renewal options and escalation clauses and require the Company to
pay taxes, insurance and maintenance costs.
Legal Proceedings
Various claims and actions, considered normal to the Company's business, have
been asserted and are pending against the Company. The Company believes that
such claims and actions will not have any material adverse effect upon the
Company's consolidated financial position or results of operations.
F-12
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
6. Stockholders' Equity
Initial Public Offering and Spin-off of uBid, Inc.
On December 9, 1998, uBid, Inc., a subsidiary of the Company at that time,
completed an initial public offering (the "Offering") of 1,817,000 shares of
common stock at an offering price of $15.00 per share. Net proceeds to uBid
were $23,847. The shares sold to the public in the offering represented
approximately 19.9% of uBid's outstanding common stock. As a result of the
Offering, the Company's share of the amount of the Offering Proceeds in excess
of the corresponding carrying value of uBid equity in the amount of $18,943 was
credited to additional paid-in capital. As discussed in Note 1, the Company's
remaining interest in uBid was subsequently spun off to the Company's
shareholders in June 1999, resulting in a charge of $8,877 to additional paid-in
capital in 1999.
Treasury Stock
In July 1996, the Company announced its plan to repurchase up to 1,000,000
shares of its Common Stock. The shares will be repurchased from time to time at
prevailing market prices, through open market or negotiated transactions,
depending upon market conditions. No limit was placed on the duration of the
repurchase program. There is no guarantee as to the exact number of shares that
the Company will repurchase. Subject to applicable securities laws, repurchases
may be made at such times and in such amounts as the Company's management deems
appropriate. The program can also be discontinued at any time management feels
additional purchases are not warranted. The Company will finance the repurchase
plan with existing working capital. As of December 31, 1999, the Company has
repurchased 15,000 shares.
7. Employee Benefits
401(k) Savings Plan
Effective January 1, 1994, the Company adopted a 401(k) Savings Plan which
covers substantially all full-time employees who meet the plan's eligibility
requirements. Participants may make tax-deferred contributions of up to 15% of
annual compensation (subject to other limitations specified by the Internal
Revenue Code). In December 1995, the Company amended the Plan to make a 25%
matching contribution for amounts which do not exceed 4% of the participants'
annual compensation. During 1999, 1998 and 1997, the Company incurred $142, $87
and $84, respectively, of expenses related to the 401(k) matching component of
this plan.
1994 Employee Stock Option Plan
In November 1994, the Board of Directors and stockholders of the Company
approved the 1994 Stock Option Plan (the "1994 Plan"), which provides for the
grant of stock options to employees and consultants of the Company. Under the
1994 Plan, the Company may grant options ("Incentive Stock Options") within the
meaning of Section 422A of the Internal Revenue Code, or options not intended to
qualify as Incentive Stock Options ("Nonstatutory Stock Options"). A total of
1,950,000 shares are reserved for issuance upon the exercise of options granted
under the 1994 Plan, and 150,706 shares of authorized but unissued shares are
available for future grants as of December 31, 1999. All options granted
through December 31, 1999 have been Nonstatutory Stock Options.
F-13
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The 1994 Plan is administered by the Compensation and Stock Option Committee
of the Board of Directors. Subject to the provisions of the 1994 Plan, the
Committee has the authority to select the employees and consultants to whom
options are granted and determine the terms of each option, including (i) the
number of shares of common stock covered by the option, (ii) when the option
becomes exercisable, (iii) the option exercise price, which must be at least
100%, with respect to Incentive Stock Options, and at least 85%, with respect to
Nonstatutory Stock Options, of the fair market value of the common stock as of
the date of grant, and (iv) the duration of the option (which may not exceed ten
years). All options generally vest annually over five years, and are
nontransferable other than by will or by the laws of descent and distribution.
1995 Director Stock Option Plan
The Company adopted the Directors' Non-Qualified Stock Option Plan (the
"Director Plan") in 1995. In 1999, the Company increased the total number of
shares reserved for issuance under the Director Plan to 100,000 from 50,000, of
which options to purchase 33,000 shares are outstanding as of December 31, 1999.
Under the Director Plan each non-employee director of the Company ("Non-
Employee Director") receives a non-qualified option to purchase 5,000 shares of
Common Stock (an "Initial Grant") upon his or her first election or appointment
to the Board of Directors. In addition, the Director Plan provides that each
Non-Employee Director who is a director immediately prior to an annual meeting
of the Company's stockholders and who continues to be a director after such
meeting will be granted an option to purchase 5,000 shares of Common Stock (a
"Subsequent Grant"); provided that no Subsequent Grant will be made to any Non-
Employee Director who has not served as a director of the Company, as of the
time of such annual meeting, for at least one year. The exercise price per
share of each option granted under the Director Plan will be the fair market
value of the Company's Common Stock on the date the option is granted. Options
granted under the Director Plan vest on the first anniversary of the date of
grant, subject to earlier vesting upon a change of control or corporate
transaction.
The following table summarizes stock option activity:
Weighted
Average
Number Exercise Price
---------- --------------
Outstanding at December 31, 1996 720,714 $6.36
Granted 351,750 7.61
Canceled (176,593) 7.00
Exercised (41,694) 5.42
----------
Outstanding at December 31, 1997 854,177 6.80
Granted 500,100 8.43
Canceled (290,893) 8.04
Exercised (159,031) 6.26
----------
Outstanding at December 31, 1998 904,353 7.34
Granted 1,758,048 5.04
Canceled (1,014,907) 7.72
Exercised (139,029) 6.15
----------
Outstanding at December 31, 1999 1,508,465 4.54
==========
F-14
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Of the options outstanding at December 31, 1999, 1998 and 1997, options to
purchase 361,632, 306,483 and 274,914 shares were exercisable at weighted
average prices of $1.88, $6.41 and $6.21 per share, respectively. The following
table summarizes information concerning currently outstanding and exercisable
stock options:
Options exercisable at
Options Outstanding at December 31, 1999 December 31, 1999
-------------------------------------------------- ------------------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- -------------------------- -------------------------------------------------- ------------------------------
$1.33-$ 1.96 536,090 7.35 $1.73 286,083 $1.70
$1.99-$ 6.88 661,400 9.33 $5.54 75,349 $2.55
$7.00-$10.63 310,975 9.45 $7.26 200 $8.50
--------------- ---------------
1,508,465 361,632
=============== ===============
The fair value of each stock option grant has been estimated pursuant to
SFAS 123 on the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions:
1999 1998 1997
--------- --------- ---------
Risk free interest rates 6.10% 4.89% 6.34%
Expected dividend yield none none none
Expected lives 7 yrs. 7 yrs. 6 yrs.
Expected volatility 124.0% 100.0% 80.0%
The weighted average grant date fair values of options granted under the
Plans during 1999, 1998 and 1997 were $7.41, $7.11 and $5.55, respectively.
1999 eCOST.com Employee Stock Option Plan
The Company adopted the eCOST.com Employee Stock Option Plan in 1999.
During 1999, options to purchase 537,000 shares of eCOST.com common stock were
granted at a weighted average exercise price of $0.20. Options generally vest
annually over five years, and are nontransferable other than by will or by the
laws of descent and distribution.
FAS 123 Pro Forma Information
The Company accounts for its stock option plans under APB Opinion No. 25.
Had compensation expense for these plans been determined consistent with SFAS
123, the Company's net income (loss) and net income (loss) per share would have
been adjusted to the pro forma amounts in the following table.
1999 1998 1997
--------- ---------- -------
Net income (loss) As Reported $(10,943) $(17,795) $4,125
Pro Forma $(12,943) $(18,097) $3,549
Diluted net income (loss)
per share As Reported $ (1.05) $ (1.75) $ 0.41
Pro Forma $ (1.25) $ (1.78) $ 0.37
F-15
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
8. Supplemental Disclosures of Cash Flow Information
1999 1998 1997
------------ ------------ ------------
Cash paid during the year ending December 31:
Interest $ 407 $ 851 $ 488
Income taxes $ 12 $ 281 $ 538
Non-cash investing and financing activities:
Borrowing incurred in connection with the
acquisition of Elek-Tek, Inc. -- -- $20,731
Equipment acquired under capital lease
obligations $ 409 -- $ 73
Notes payable assumed in connection with
acquisition of ComputAbility -- -- $ 380
9. Acquisitions
On August 29, 1997, the Company acquired the assets and assumed the
liabilities of Milwaukee-based ComputAbility, Ltd., ("ComputAbility") a
privately held direct market reseller of PC/WINTEL hardware, peripheral and
software products, for $8,000 consisting of $5,500 paid in cash and the
remainder through the issuance of 271,739 shares of common stock valued at
$2,500. The acquisition of ComputAbility has been accounted for using the
purchase method and the operating results of ComputAbility have been combined
with those of the Company since the date of acquisition. The total cost of the
acquisition exceeded the fair value of the net assets acquired and liabilities
assumed by $6,763 and, accordingly, the excess has been recorded as goodwill and
is being amortized using the straight-line basis over 25 years.
On October 15, 1997, the Company acquired substantially all of the assets
of Elek-Tek, Inc. ("Elek-Tek"), a Delaware corporation, for a purchase price of
$29,400 plus direct costs of the acquisition pursuant to an Asset Purchase
Agreement dated September 17, 1997, as amended. Such assets consisted primarily
of accounts receivable, inventory, property, plant and equipment, certain
intangibles and customer lists and the businesses associated with mail order,
direct sales and retail activities. The acquisition was completed as a result of
bankruptcy court approval of the agreement signed by the Company and Elek-Tek in
connection with the September 17, 1997 filing by Elek-Tek for protection under
Chapter 11 of the U.S. Bankruptcy Code. Elek-Tek currently operates as a wholly
owned subsidiary of the Company under the name CCIT.
The Elek-Tek acquisition was accounted for as a purchase. Accordingly, the
operating results of Elek-Tek have been combined with those of the Company since
the date of acquisition. The Company borrowed $20.7 million of the purchase
price from Deutsche Financial Services Corporation, and the remaining $8.7
million was paid in cash. The purchase price was allocated to the net assets
acquired based upon their estimated fair values at the date of acquisition. The
excess of the purchase price over the net assets acquired of $8,468 is being
amortized using the straight line basis over 25 years. In connection with the
acquisition of Elek-Tek, the Company incurred expenses of $1,470 in the fourth
quarter of 1997. These expenses related primarily to integrating Elek-Tek's
sales force and customer base into the Company.
The following table reflects unaudited pro forma combined results of
operations of the Company, ComputAbility and Elek-Tek as if these acquisitions
had occurred at the beginning of the year presented. However, these pro forma
results are not necessarily indicative of the actual results of operations that
would have occurred.
F-16
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
1997
---------
Net sales $791,345
Net income $ 1,046
Diluted earnings per share $ 0.10
10. Headquarters Move
In November 1997, the Company consolidated its headquarters and
telemarketing facilities into a 160 thousand square foot building in Torrance,
CA. The charge associated with the move was $815, and was expensed in the fourth
quarter of 1997.
11. Retail Store Closures
During February 1998, the Company closed its Indiana retail showroom. On
March 20, 1998, the Company closed six retail showrooms to focus its efforts on
its catalog, corporate and Internet channels of distribution. The Company
recorded a one-time pretax restructuring charge of $10.5 million in 1998
relating to exit costs associated with the closing of retail operations.
Recorded in selling, general and administrative costs were $3.1 million in
write-offs of goodwill, $1.9 million in write-offs of fixed assets, a $1.5
million reserve for lease exit costs, and $0.3 million in employee-related
severance costs. Recorded in cost of sales were $3.7 million of reserves for
store inventory. All reserves were utilized by December 31, 1998.
12. Segment Information
The Company operates in two reportable segments: 1) a direct marketer of
personal computers, hardware, software, peripheral products and consumer
electronics under the PCMall, MacMall, ComputAbility and CCIT brands; and 2) a
Multi-Category Internet retailer under the eCOST.com brand.
Summarized segment information for continuing operations for the year ended
December 31, 1999 is as follows:
Direct Multi-Category
Marketer Internet Consolidated
----------- -------------- -------------
Net sales $695,165 $36,790 $731,955
Gross profit 79,290 261 79,551
Operating income (loss) 2,047 (6,183) (4,136)
Total assets 146,185 5,348 151,533
Segment information is not provided for the years ended December 31, 1998
and December 31, 1997, as the Company did not operate in the Multi-Category
Internet segment until the formation of eCOST.com in April 1999.
The Company no longer operates in the Internet Auction segment as a result
of the spin-off of uBid, Inc. in 1999.
F-17
CREATIVE COMPUTERS, INC.
QUARTERLY FINANCIAL INFORMATION
(unaudited)
(in thousands, except per share data)
1999
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Net Sales $176,289 $161,535 $172,377 $221,754
Gross Profit 20,037 18,982 18,215 22,317
Income (loss) from continuing operations 388 (277) (2,533) (2,281)
Loss from discontinued operations (2,685) (3,555) - -
Net income (loss) (2,297) (3,832) (2,533) (2,281)
Basic earnings (loss) per share
Continuing operations $ 0.04 $ (0.03) $ (0.24) $ (0.22)
Discontinued operations (0.26) (0.34) - -
-------- -------- -------- --------
$ (0.22) $ (0.37) $ (0.24) $ (0.22)
======== ======== ======== ========
Diluted earnings (loss) per share
Continuing operations $ 0.04 $ (0.03) $ (0.24) $ (0.22)
Discontinued operations (0.26) (0.34) - -
-------- -------- -------- --------
$ (0.22) $ (0.37) $ (0.24) $ (0.22)
======== ======== ======== ========
See Note 1 to the consolidated financial statements for a discussion of the
uBid spin-off.
1998
-----------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
Net Sales $162,059 $143,183 $170,442 $166,322
Gross Profit 12,394 18,002 20,041 19,581
Income (loss) from continuing operations (12,234) 808 1,112 1,490
Loss from discontinued operations (575) (596) (677) (7,123)
Net income (loss) (12,809) 212 435 (5,633)
Basic earnings (loss) per share
Continuing operations $ (1.21) $ 0.08 $ 0.11 $ 0.15
Discontinued operations (0.05) (0.06) (0.07) (0.70)
-------- -------- -------- --------
$ (1.26) $ 0.02 $ 0.04 $ (0.55)
======== ======== ======== ========
Diluted earnings (loss) per share
Continuing operations $ (1.21) $ 0.08 $ 0.11 $ 0.15
Discontinued operations (0.05) (0.06) (0.07) (0.70)
-------- -------- -------- --------
$ (1.26) $ 0.02 $ 0.04 $ (0.55)
======== ======== ======== ========
See Note 11 to the consolidated financial statements for a discussion of
special charges for the year ended December 31, 1998.
F-18
SCHEDULE II
CREATIVE COMPUTERS, INC.
Valuation and Qualifying Accounts
For the years ended December 31, 1997, 1998 and 1999
(in thousands)
Balance at Additions Deduction Balance
Beginning Charged to from at End
of Year Operations Reserves of Year
---------- ---------- --------- -------
Allowance for doubtful accounts for the year ended:
December 31, 1997 $2,134 $ 5,680 $ (4,955) $2,859
December 31, 1998 2,859 3,927 (3,110) 3,676
December 31, 1999 3,676 3,206 (5,399) 1,483
Reserve for inventory for the year ended:
December 31, 1997 6,304 6,548 (7,488) 5,364
December 31, 1998 5,364 6,172 (6,796) 4,740
December 31, 1999 4,740 2,019 (4,428) 2,331
Restructuring reserve for the year ended:
December 31, 1998 - 10,452 (10,452) -
Deferred tax asset valuation allowance for the year ended:
December 31, 1999 - 3,380 - 3,380
F-19