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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, 1998
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
-------------------
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 [_] No [X]
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 26, 1999, the aggregate market value of the Common Stock held
by non-affiliates of the Registrant was approximately $226 million. The number
of shares outstanding of the Registrant's Common Stock as of March 26, 1999 was
10,375,893.
Documents incorporated by reference into Part III: Portions of the
definitive Proxy Statement for the Registrant's 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.
CREATIVE COMPUTERS, INC.
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 24
Item 3. Legal Proceedings................................................. 24
Item 4. Submission of Matters to a Vote of Security Holders............... 24
PART II
Item 5. Market for Registrant's Common Stock
and Related Stockholder Matters................................... 25
Item 6. Selected Financial Data........................................... 26
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 27
Item 7A. Quantitative and Qualitative Disclosures about Market Risk........ 33
Item 8. Financial Statements and Supplementary Data....................... 33
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............................ 33
PART III
Item 10. Directors and Executive Officers of the Registrant................ 34
Item 11. Executive Compensation............................................ 34
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 34
Item 13. Certain Relationships and Related Transactions.................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K... 35
SIGNATURES..................................................................... 37
2
PART I
In accordance with the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), the Securities and Exchange Commission (the "Commission")
allows us to "incorporate by reference" information into this Report, which
means that we can disclose information required in this Report by referring you
to another filing separately submitted to the Commission. The information so
incorporated by reference is deemed to be part of this Report.
Specified portions of this Report are incorporated by reference to the
Annual Report on Form 10-K of uBid, Inc., a majority-owned subsidiary of
Creative Computers, Inc., for the year ended December 31, 1998, which was filed
with the Commission on March 31, 1999 (the "uBid 1998 10-K"). Creative and uBid
are each subject to the informational requirements of the Exchange Act and file
reports, proxy statements and other information with the Commission. These
reports are available at the public reference facility maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the Commission's regional offices located at Seven World
Trade Center, New York, New York 10048 and Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such
material may also be obtained from the Public Reference Section of the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates, and may also be found on the Commission's Internet site at
http://www.sec.gov.
ITEM 1. BUSINESS
General
Creative Computers, Inc. (the "Company"), founded in 1987, is a direct
marketer of personal computer hardware, software and peripheral products. 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
distinctive full-color catalogs, including MacMall, PC Mall, and ComputAbility,
other promotional materials and the Company's four worldwide websites on the
Internet, pcmall.com, macmall.com, computability.com and ccit-inc.com. 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. During 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. 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.
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 retail showrooms to focus its efforts on its catalog,
corporate and Internet channels. Net sales from the Company's retail showroom
operations were $57.9 million, $67.8 million and $43.6 million for the years
ended December 31, 1996, 1997 and 1998, representing 13.0%, 12.4% and 6.3% 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 $3.1 million write-off of goodwill, $1.9 million
write-off for fixed assets, $1.5 million reserve for lease exit costs, and $0.3
million in employee-related severance costs. Recorded as cost of sales were
$3.7 million of reserves for store inventory.
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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
beneficially owned 80.1% of the outstanding Common Stock of uBid. The Company
has announced that it intends to distribute (the "Distribution") to its
stockholders, prior to December 31, 1999, all of its shares of Common Stock of
uBid, subject to certain conditions. See "Separation of uBid from the Company."
A description of uBid's business is contained in Part I, Item 1 of the uBid 1998
10-K under the caption "The Company" and is incorporated herein by reference.
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. Specific elements of the Company's operating strategy include:
Expansion into Outbound Telemarketing. During 1998, the Company intensified
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 the year, the Company hired experienced
outbound telemarketing executives to manage this initiative and experienced
outbound telemarketing recruiters to aggressively 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 aggressively 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.
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 and completed a successful
initial public offering ("IPO") of uBid in December 1998. The Company was also
among the first to offer Electronic Software Distribution (ESD) that allows
customers to purchase and download software from its web site.
During 1998, the Company continued to introduce new Internet innovations
including a complete redesign of its macmall.com, pcmall.com, computability.com,
and ccit-inc.com web sites during the fourth quarter. Innovations introduced to
the web sites include: ProductPro- a context sensitive shopping tool that allows
Web users to quickly and intuitively locate products that meet their needs and
preferences; Product Comparisons- online customers can compare selected products
in a side-by-side grid format to aid in purchasing decisions and Product
Availability- availability of merchandise as the actual item count in the
Company's Memphis warehouse and selected distribution partners' warehouses. The
Company intends to take advantage of its e-commerce experience and continue to
introduce new innovations to grow its Internet retail position.
In March 1999, the Company launched eCost.com as a new wholly owned
subsidiary. eCOST.com offers a broad selection of name-brand products, most of
which are sold at or below wholesale cost. Customers are provided an itemized
description of the fees associated with processing their orders. These fees
include the costs of warehousing, administrative and shipping expenses, as well
as a small order processing fee. With the introduction of eCOST.com, the Company
is among the first full-spectrum Internet resellers in the personal computing
marketplace, offering customers many distinct and different ways to purchase
computer hardware, software, peripherals and consumer electronics.
Spin-off of uBid. During September 1997, the Company formed uBid as a
subsidiary of the Company to sell computers, computer-related products, consumer
electronics, housewares, and sports and recreation products through an auction
format on the Internet. When visiting the uBid website, shoppers review an item
or group of items and offer bids, driving the price toward a true market value.
During the auction, bidders are notified via e-mail when they are outbid by a
competing shopper. Customers can
4
increase their bid by simply replying to the e-mail or by returning to the fast-
paced action at the uBid website. When the auction closes, the highest bidders
win the merchandise at the price they bid for it.
On December 9, 1998, uBid completed an initial public offering of 1,817,000
shares of its Common Stock, raising $23.8 million for uBid's advertising, brand
and infrastructure development and for general corporate purposes. As of March
25, 1999, the Company owned approximately 80.1% of the outstanding common stock
of uBid. The Company has announced that it intends to distribute to
shareholders, subject to the satisfaction of certain conditions, its ownership
in uBid by means of a tax-free stock dividend in 1999, but in no event prior to
June 7, 1999.
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 and thirteen editions with a circulation of 15.3 million copies
in 1996 and more than doubled its year-over-year WINTEL-based revenue. During
1997, the Company published fourteen editions of PC Mall with a circulation of
21.9 million copies and three editions of its ComputAbility catalog with a
circulation of 1.5 million copies during the third and fourth quarters,
resulting in a combined WINTEL catalog circulation increase of 53%. The
increased catalog circulation coupled with the Company's acquisitions of Elek-
Tek and ComputAbility caused its 1998 WINTEL revenue mix to exceed 50% for the
first time. WINTEL revenue for 1998 increased to $365 million, a 65% increase
over 1997. In 1998, the Company continued to expand WINTEL catalog circulation,
publishing fourteen editions of PC Mall Business Solutions with a circulation of
25.8 million copies and thirteen editions of its ComputAbility catalogs with a
circulation of 9.1 million copies. WINTEL catalog circulation increased during
1998 by 49% over 1997.
The Company is authorized or otherwise has the ability to sell IBM, Compaq,
Hewlett-Packard, Sony, Hitachi, Toshiba, Fujitsu 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 1998, 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 declined 14% to $279 million for 1998 from $325 million in
1997; however, the third and fourth quarters of 1998 experienced the first MAC
sales growth since January 1996. The Company plans to continue its efforts to
expand its Macintosh market share. In the third quarter of 1998, the Company
launched a Mac Software catalog as part of that effort. During 1998, the
Company published fourteen editions of its MacMall catalog with a circulation of
33.0 million copies, an 8% decrease from last year's 36.0 million circulation
and a 9% increase over the 30.3 million copies circulated in 1996.
Marketing Database Growth. The Company has compiled a proprietary mailing
list of nearly 5 million names of previous and potential customers and has added
to the database through the acquisitions of Elek-Tek and ComputAbility. 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 1998 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. The sales executive is trained and empowered to
handle all customer needs including customer service and returns-related issues.
Additionally, sales executives bring other expertise to bear as needed from
within the Company including Novell-trained
5
Certified Network Engineers (CNE), Microsoft Windows NT specialists (MCSE) and
Apple-certified technicians.
The information pertaining to uBid's business strategy is contained in the
uBid 1998 10-K in Part I, Item 1 under the caption "Business Strategy" and is
incorporated herein by reference. See "Separation of uBid from the Company."
Marketing and Sales
The Company's various marketing programs are designed 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 user magazines, such as PC World, PC Magazine, Computer Shopper and
MacWorld. In addition, the Company obtains the names of prospective customers
through the use of 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 1998, the Company shipped
approximately 1,196,000 mail order/catalog orders with an average order size of
$502. The Company distributes its catalogs throughout the United States.
Catalogs. The Company published fourteen editions of its PC Mall catalogs
during 1998 and distributed approximately 25.8 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 1998 and distributed
approximately 33 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.
The Internet. The Company offers worldwide websites on the Internet that
can be accessed via its four catalog names, pcmall.com, macmall.com,
computability.com and ccit-inc.com. During 1997, the Company expanded its
Internet retail offerings by launching uBid, an Internet site that sells
computer and other electronic products through an auction format. The Company
maintains direct links to its PC Mall website on AOL (through the AOL Shopping
Channel) and on the uBid Internet site.
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 website also
serves as another source of new customers.
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
6
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. The Company's toll-free order numbers are staffed by
sales executives 24 hours a day, seven days a week. Inbound and outbound
telemarketing sales executives are assisted by customer service and technical
support personnel.
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 ad 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 1998, the Company purchased 582 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.
The information pertaining to uBid's marketing and sales is contained in
the uBid 1998 10-K in Part I, Item 1 under the caption "Sales and Marketing" and
is incorporated herein by reference.
Products and Merchandising
The Company offers hardware, software, peripherals, components and
accessories for users of computer products. The Company screens new products and
selects products for inclusion in its catalogs 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, the Company is able to
quickly introduce new products and replace slower selling products with new
products.
The following table sets forth the Company's (excluding uBid) net sales and
percentage of net sales by major product category for the periods presented.
7
Year Ended December 31,
(in millions of dollars)
1996 % 1997 % 1998 %
---------- ----------- ---------- ----------- ---------- -----------
Computer systems............ $166.9 37.5% $231.1 42.3% $273.0 42.4%
Peripherals, components 227.8 51.2 247.9 45.4 291.7 45.3
and accessories..........
Software.................... 45.4 10.2 60.9 11.2 68.5 10.6
Other (1)................... 4.9 1.1 6.2 1.1 10.9 1.7
------ ----- ------ ----- ------ -----
Total.................. $445.0 100.0% $546.1 100.0% $644.1 100.0%
====== ===== ====== ===== ====== =====
(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, Hitachi,
Toshiba, Fujitsu and others. The Company is also authorized or otherwise has the
ability 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 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.
The information pertaining to uBid's products and merchandising is
contained in uBid 1998 10-K in Part I, Item 1 under the caption "Products and
Merchandising" and is incorporated herein by reference.
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. The Company purchases products from over 900
vendors. During 1996, 1997 and 1998, products manufactured by Apple represented
approximately 30.1%, 21.4% and 20.0% of net sales, respectively. The Company is
also linked electronically with three 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
8
costs and improved inventory turns. The Company intends to expand its use of
virtual warehouse in the future.
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, in part,
dependent 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 1998. The Company's average
annual inventory turns were 7.7 times in 1996, 9.9 times in 1997 and 13.5 times
in 1998. 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 which contain price protection provisions
intended to reduce, in part, 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 personal computers, peripherals and software 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.
The information pertaining to uBid's purchasing and inventory is
incorporated by reference to uBid's 1998 10-K in Part I, Item 1, under the
caption "Vendor Relationships."
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
product 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. In July 1998,
uBid entered into a sublease with the Company currently covering 100,000 square
feet of the Company's 325,000 square foot facility. The uBid sublease agreement
is co-terminus with the building lease.
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.
9
The Company believes that its existing distribution facilities are
currently adequate for its needs.
The information pertaining to uBid's distribution and order fulfillment is
contained in the uBid 1998 10-K in Part I, Item 1 under the caption "Order
Fulfillment" and is incorporated herein by reference.
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
allows the preparation of daily operating control reports which provide concise
and timely information 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, including 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.
10
Retail Computer Showrooms
During 1997, the Company operated four retail computer showrooms in
Southern California and four retail computer showrooms in the Midwest, ranging
in size from approximately 3,400 to 40,000 square feet of space. However, the
Company has focused its expansion efforts and resources on the direct mail
channel. As of March 25, 1999, the Company operated one retail computer
showroom, located in Santa Monica, California.
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 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.
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,
onsale@cost 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
11
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 low 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 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.
The information pertaining to uBid's competition is contained in the uBid
1998 10-K in Part I, Item 1 under the caption "Competition" and is incorporated
herein by reference.
Employees
As of December 31, 1998, the Company employed 974 full-time people,
including 159 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. New account executives participate in an intensive four-week
training program, during which time they are introduced to the Company's
philosophy, available resources, products and services. 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 gross profit dollars 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.
12
Properties
The Company's facilities at December 31, 1998 were as follows:
Description Sq. Ft. Location
- ----------- ---------- ---------------------
Creative Computers Corporate Headquarters.... 98,300 Torrance, CA
Distribution Center.......................... 325,000 Memphis, TN
Retail Showroom.............................. 13,050 Santa Monica, CA
CCIT/uBid Corporate Headquarters............. 28,685 Elk Grove Village, IL
Kansas Property.............................. 32,800 Lenexa, KS
CCIT Colorado Corporate Sales................ 2,315 Englewood, CO
CCIT Indiana Corporate Sales................. 6,500 Indianapolis, IN
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 retail showroom, and
the ComputAbility Corporate headquarters each of which is owned by the Company.
The Company's distribution center serves the Company's catalog, Elek-Tek and
ComputAbility operations as well as its retail showrooms. The Memphis facility
includes shipping, receiving, warehousing and administrative space. The Company
subleases 100,000 square feet of its distribution center to uBid. The following
leases have remaining terms greater than two years: Creative Computers corporate
headquarters, Memphis distribution center and Elek-Tek/uBid corporate
headquarters. All of the other leases have remaining terms less than two years.
During the fourth quarter of 1997, the Company consolidated its headquarters
facility and its telemarketing operations into a 160,000 square foot building in
a nearby location in Torrance, CA. The Company currently occupies 98,300 square
feet and plans to phase into the remaining space in the near future. 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.
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 currently is 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 its various subsidiaries, currently collects and remits sales
tax only on sales of 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
13
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.
Separation of uBid from the Company
Background of the Separation and Distribution. The Company has
announced that, subject to certain conditions, the Company intends to separate
uBid from the Company's other operations and businesses (the "Separation") and
to distribute to its stockholders (the "Distribution") all of the uBid common
stock owned by the Company in no event prior to 180 days after the December 9,
1998 closing date of uBid's initial public offering. The Separation will
establish uBid as a stand-alone entity with objectives separate from those of
the Company. In December 1998, uBid and the Company entered into a Separation
and Distribution Agreement (the "Separation and Distribution Agreement") and
certain other agreements providing for the Separation and the Distribution, the
provision by the Company of certain interim services to uBid, and addressing
employee benefit arrangements, and tax and other matters. These agreements (the
"Ancillary Agreements") are discussed in Part I, Item 1 of the uBid 1998 10-K
under the caption "Transactions between the Company and the Parent" and are
incorporated herein by reference. As of March 25, 1999, the Company owned
approximately 80.1% of the outstanding common stock of uBid.
The Company and uBid believe that the Separation and the Distribution
will enhance uBid's ability to implement its growth and operating strategies.
uBid believes that its future growth would be enhanced if its management were
compensated on a separate basis from the Company. The Company believes that
the Company's future growth would be enhanced if management of its remaining
business segments were more focused on such segments without also being
responsible for the online auction segment. Upon completion of the
Distribution, holders of Common Stock of the Company as of the record date for
the Distribution will be entitled to receive a dividend of uBid common stock
without the payment of further consideration, although the Company expects the
market value of shares of the Company's Common Stock to diminish upon effecting
the Distribution to reflect the value (per share of Company Common Stock) of the
shares of uBid common stock distributed by the Company. The consummation of the
Distribution will also remove current restrictions on uBid's growth as a result
of certain contractual restrictions of the Company that are applicable to the
Company and its subsidiaries. For example, certain of the Company's contractual
relationships with manufacturers prevent the Company and its subsidiaries,
including uBid, from selling such manufacturers' computers and computer-related
products at discounted prices, which has prevented uBid from obtaining such
products on a close-out or refurbished basis and selling them in uBid's
auctions. In addition, under the Company's contractual relationships with
certain of its vendors, neither the Company nor its subsidiaries, including
uBid, can sell the vendor's products outside the U.S. As a result of the
Distribution, uBid would no longer be subject to some of these restrictions.
14
Conditions to the Distribution. The Company has received the opinion
of PricewaterhouseCoopers LLP (the "PwC Opinion") to the effect that the
Distribution will qualify as a tax-free distribution for federal income tax
purposes under Section 355 of the Internal Revenue Code of 1986, as amended (the
"Code"), and will not result in recognition of any gain or loss for federal
income tax purposes to the Company, uBid, or the Company's or uBid's respective
stockholders. Although the Company does not presently intend to do so, the
Company also may apply for a private letter ruling ("Letter Ruling") from the
Internal Revenue Service. In accordance with the Separation and Distribution
Agreement, completion of the Distribution will be subject to the satisfaction,
or waiver by the Company's Board of Directors, of the following conditions: (i)
the PwC Opinion shall have been obtained, in form and substance satisfactory to
the Company, and be confirmed at the time of Distribution; (ii) if the Company
decides to seek a Letter Ruling, the Letter Ruling shall have been obtained and
remain effective consistent with the conclusions reached in the PwC Opinion, and
such ruling shall be in form and substance satisfactory to the Company, in its
sole discretion; (iii) any material Governmental Approvals and Consents (as such
terms are defined in the Separation and Distribution Agreement) necessary to
consummate the Distribution shall have been obtained and shall be in full force
and effect; (iv) no order, injunction or decree issued by any court or agency of
competent jurisdiction or other legal restraint or prohibition preventing the
consummation of the Distribution shall be in effect, and no other event outside
the control of the Company shall have occurred or failed to occur that prevents
the consummation of the Distribution; and (v) no other events or developments
shall have occurred that, in the judgment of the Company's Board of Directors,
would result in the Distribution having a material adverse effect on the Company
or on the stockholders of the Company. The Company's Board of Directors will
have the sole discretion to set the Distribution date for any time commencing
after June 7, 1999. The Company has agreed to consummate the Distribution,
subject to the satisfaction of the conditions set forth above. The Company may
terminate the obligation to consummate the Distribution if the Distribution has
not occurred by December 31, 1999, unless extended by the Company and uBid. In
addition, the Separation and Distribution Agreement may be amended or terminated
at any time prior to the Distribution date by the mutual consent of uBid and the
Company. See "Certain Factors Affecting Future Results--Pending Distribution."
A more detailed description of the Ancillary Agreements and the
historical relationship between the Company and uBid is contained in Part I,
Item 1 of the uBid 1998 10-K under the caption "Transactions between the Company
and the Parent" and is incorporated herein by reference.
Executive Officers
The executive officers of the Company as of March 26, 1999 and their
respective ages and positions are as follows:
Name Age Position
---- --- --------
Frank F. Khulusi............... 32 Chairman of the Board,
Chief Executive Officer and President
S. Keating Rhoads.............. 49 Chief Operating Officer and
Executive Vice President
Theodore R. Sanders............ 44 Chief Financial Officer
Daniel J. DeVries.............. 37 Executive Vice President - Marketing
and Sales
The following is a biographical summary of the experience of the executive
officers:
15
Frank F. Khulusi is a co-founder of the Company and has served as Chairman of
the Board, President and Chief Executive Officer of the Company since the
Company's inception in 1987. Mr. Khulusi attended the University of Southern
California.
S. Keating Rhoads joined the Company in January 1999 as Executive Vice
President and Chief Operating Officer. Previously with the Times Mirror Company
for fourteen years, Mr. Rhoads served as Senior Vice President, Operations at
the flagship Los Angeles Times. He earned an MBA degree from Columbia
University and an A.B. degree from Stanford 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 retail showrooms. 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
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for "forward-looking statements" to encourage companies to provide
prospective information, so long as such information is identified as forward
looking and is accompanied by meaningful cautionary statements identifying
important factors that could cause actual results to differ materially from
those discussed in the statement. Except for historical information, certain
statements contained in this Annual Report on Form 10-K are "forward-looking
statements" within the meaning of the Act. In order to take advantage of the
"safe harbor" provisions of the Act, the Company identifies the following
important factors which could affect the Company's actual results and cause such
results to differ materially from those projected, forecasted, estimated,
budgeted or otherwise expressed by the Company in "forward-looking statements"
made by or on behalf of the Company:
(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.
16
(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 distribute its ownership in uBid by means
of a tax-free stock dividend in the time frame contemplated or at all
could materially adversely affect the Company and the market price of
the Company's Common Stock.
It is not reasonably possible to itemize all of the many factors and specific
events that could affect the Company and/or the microcomputer 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 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."
The information pertaining to certain factors affecting future results of
uBid is contained in the uBid 1998 10-K in Part I, Item 1 under the caption
"Investment Considerations" and is incorporated herein by reference.
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 30.1%, 21.4% and 20.0% of the Company's net sales in
1996, 1997 and 1998, 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 1996 and 1997, 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 were 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
17
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 $690.2 million in 1998. The Company's
catalog sales grew from $117.9 million in 1994 to $598.4 million in 1998.
Internet sales on its ubid.com, pcmall.com, macmall.com, computability.com and
ccit-inc.com web sites grew from $15.2 million in 1997 to $83.3 million in 1998.
As a result of the Company's shift from the retail showroom to the catalog
distribution channel, retail showroom sales have decreased from 28.0% of net
sales in 1994 to 6.3% in 1998. 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 recent 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, Hitachi, Toshiba, Fujitsu 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 and related products is highly
competitive, based primarily on price, product availability, speed and accuracy
of delivery, effectiveness of sales and 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,
onsale@cost 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 industry, 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 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 there can be no
assurance that the Company will not be subject to increased price
18
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 microcomputer products
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 in general, seasonal shifts in
demand for hardware and software products, industry announcements and market
acceptance of new products or upgrades, including 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 or
delays in the release by suppliers of new products and inventory adjustments.
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 discontinuance of the agreements with these vendors, could adversely affect
the Company's operating income and cash flow. The Company's success is, in
part, dependent 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
19
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 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 personal computers and related software and products are
distributed and sold is changing, and new methods of sale and distribution, such
as the Internet, have emerged. 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, for the delivery of its products. The
disruption or termination of the Company's arrangements with Federal Express 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 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.
20
Risk of Technological Changes and Inventory Obsolescence
The market for personal computers, peripherals and software is characterized
by rapid technological change and a growing diversity of products. The recent
growth in sales of personal computers and related software and peripherals has
been, in part, due to the introduction of new hardware and software, including
multimedia personal computer systems and upgraded Apple computers. 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. Recently, 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
21
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 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 (including upgrades relating to the Company's Year
2000 compliance project) 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, President 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.
22
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 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. Additionally, the failure of the Company
to distribute its ownership in uBid by means of a tax-free stock dividend in the
time frame contemplated or at all could materially adversely affect the market
price of the Common Stock. In addition, the Company expects the market value of
the Company's Common Stock to diminish upon effecting the Distribution to
reflect the value of the shares of uBid common stock to be distributed by the
Company.
Pending Distribution
The Company has announced that, subject to certain conditions, the Company
intends to distribute to its stockholders prior to December 31, 1999 all of uBid
common stock owned by the Company. The Company has received an opinion letter
from PricewaterhouseCoopers LLP to the effect that the Distribution will qualify
as a tax-free distribution for federal income tax purposes under Section 355 of
the Code, and the Distribution is conditional upon obtaining such an opinion
letter in form and substance satisfactory to the Company and confirmation of
such opinion at the time of Distribution. Although it does not presently plan
to do so, the Company may also decide, in its sole discretion, to seek a private
letter ruling from the Internal Revenue Service in form and substance
satisfactory to the Company consistent with the conclusions reached in the PwC
Opinion. In that case, the Distribution would also be conditioned upon receipt
of the Letter Ruling. The Company intends to take all necessary steps to
complete such a tax-free distribution after obtaining the PwC Opinion and the
Letter Ruling, as applicable, but in no event will the Distribution occur prior
to June 7, 1999. The Distribution also is subject to the condition that no
events or developments occur that, in the sole judgment of the Board of
Directors of the Company, would or could result in the Distribution having a
material adverse effect on the Company or the Company's stockholders. In
addition, as a condition to the Distribution, the Company will be required to
obtain certain consents from third parties. There can be no assurance that any
of the foregoing conditions, or any other conditions to the Distribution, will
be satisfied, or that the Distribution will occur in the time frame contemplated
or at all. The failure of the Distribution to occur could materially adversely
affect the Company and the market price of the Company's Common Stock.
Year 2000
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed "year
2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with whom the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems, and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has established
an internal project team comprised of all functional disciplines. This project
team has begun a three-phase process of identifying internal systems (both
information technology and non-information technology systems) not year 2000
compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The Company
has been communicating with the suppliers and others to coordinate year 2000
readiness. The responses received by the Company to date have indicated that
steps are currently being undertaken to address this concern. However, if such
third parties are not able to make all systems and products year 2000 compliant,
there could be a material adverse impact on the Company.
Initial review of the Company's principal application software through
which nearly all of the Company's business is transacted, has determined it to
be year 2000 compliant and, as such, the Company does not anticipate any
material adverse operational issues to arise. The Company has completed 75% of
the year 2000 compliance assessment for critical systems and will complete its
assessment by the end of the second quarter of 1999. The Company plans to
implement corrective solutions before the end of the third quarter of 1999. To
date, the costs incurred by the Company with respect to this project are $0.1
million. Based on current estimates, management expects that the Company's total
costs in connection with its year 2000 compliance project will be approximately
$0.8 million and will be financed from general corporate funds; however, future
anticipated costs are difficult to estimate with any certainty and may differ
materially from those currently projected based on the results of the assessment
phase of the Company's year 2000 project. The anticipated costs associated with
the Company's year 2000 compliance program do not include time and costs that
may be incurred as a result of any potential failure of third parties to become
year 2000 compliant or costs to implement the Company's future contingency
plans. Management estimates that approximately one half of the expected costs
will be attributed to the redeployment of internal resources and the other half
will be comprised principally of external consulting fees and software upgrades.
No hardware expenditures for year 2000 are contemplated. The redeployment of
internal data processing resources is not expected to materially delay any
significant projects. Year 2000 spending is expected to be 10% of total budgeted
data processing expenditures. The Company has not yet developed a contingency
plan in the event that any non-compliant critical systems are not remedied by
January 1, 2000, nor has it formulated a timetable to create such contingency
plan. Upon completion of this project, if systems material to the Company's
operations have not been made year 2000 compliant, or if third parties fail to
make their systems year 2000 compliant in a timely manner, the year 2000 issue
could have a material adverse effect on the Company's business, financial
condition and results of operations.
23
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 1998.
24
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, 1996
----------------------------
First Quarter............... $ 18 3/4 $ 6 3/4
Second Quarter.............. 10 5/8 6
Third Quarter............... 9 7/8 4 1/2
Fourth Quarter.............. 11 3/4 7 5/16
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
On March 26, 1999, the closing price of the Company's Common Stock as
reported on the Nasdaq National Market was $33 11/16 per share. As of March 26,
1999, there were approximately 1,500 holders of record of the Common Stock.
On August 29, 1997, the Company issued 271,739 shares of its Common Stock
valued at $2.5 million to purchase ComputAbility Ltd. The shares were issued
pursuant to the exemption from the registration requirements of the Securities
Act of 1933, as amended, provided by Rule 4(2) thereunder.
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.
The Company announced in July 1996 that, depending on various factors
including market price, it would repurchase up to 1,000,000 shares of its stock.
The Company has repurchased 15,000 shares to date under this program. However,
there is no assurance that the Company will purchase additional shares.
The information pertaining to the market for uBid's common stock and related
stockholder matters is set forth in the uBid 1998 10-K in Part II, Item 5 and is
incorporated herein by reference.
25
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, 1996, 1997 and
1998 and the selected balance sheet data as of December 31, 1997 and 1998 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, 1994 and 1995 along with the balance sheet data as of
December 31, 1994, 1995 and 1996 are derived from the audited consolidated
financial statements of the Company which are not included herein. The selected
operating data are derived from the accounting records of the Company and have
not been audited.
Year Ended December 31,
-----------------------------------------------------------
(in thousands, except per share data)
1994 1995 1996 1997(1) 1998(1)
--------- --------- --------- --------- ---------
Net sales..................................... $163,706 $420,877 $444,971 $546,131 $690,238
Cost of goods sold............................ 140,229 361,803 395,000 476,061 612,566
Retail store closure inventory reserve........ - - - - 3,679
-------- -------- -------- -------- --------
Gross profit.................................. 23,477 59,074 49,971 70,070 73,993
Selling, general and administrative expenses.. 19,384 49,844 60,585 63,540 85,519
Expenses related to retail store closure...... - - - - 6,773
-------- -------- -------- -------- --------
Income (loss) before uBid stock-based
compensation................................ 4,093 9,230 (10,614) 6,530 (18,299)
uBid stock-based compensation................. - - - - 5,267
-------- -------- -------- -------- --------
Income (loss) from operations................. 4,093 9,230 (10,614) 6,530 (23,566)
Interest income (expense)..................... (759) 371 593 118 (461)
-------- -------- -------- -------- --------
Income (loss) before income taxes............. 3,334 9,601 (10,021) 6,648 (24,027)
Income taxes (benefit)........................ 1,328 3,754 (3,972) 2,523 (5,034)
-------- -------- -------- -------- --------
Income (loss) before minority interest........ 2,006 5,847 (6,049) 4,125 (18,993)
Minority interest............................. - - - - 1,198
-------- -------- -------- -------- --------
Net income (loss)............................. $ 2,006 $ 5,847 $ (6,049) $ 4,125 $(17,795)
======== ======== ======== ======== ========
Basic earnings (loss) per share (2)........... $0.41 $0.71 $(0.62) $0.42 $(1.75)
======== ======== ======== ======== ========
Diluted earnings (loss) per share (2)......... $0.39 $0.66 $(0.62) $0.41 $(1.75)
======== ======== ======== ======== ========
Basic weighted average number of shares ......... ......... .........
outstanding (2)............................. 4,900 8,291 9,767 9,895 10,176
======== ======== ======== ======== ========
Diluted weighted average number of shares ......... ......... .........
outstanding (2)............................. 5,160 8,890 9,767 10,030 10,176
======== ======== ======== ======== ========
Selected Operating Data (in thousands, except
Average order size):
Mail order/catalog net sales.................. $117,863 $353,324 $387,103 $478,291 $598,427
uBid auction net sales........................ $ - $ - $ - $ 9 $ 48,232
Retail net sales.............................. $ 45,843 $ 67,553 $ 57,868 $ 67,831 $ 43,579
Number of catalogs distributed................ 7,700 38,398 48,800 62,200 69,427
Orders filled (mail order/catalog)............ 194 784 931 1,026 1,196
Average order size (mail order/catalog)....... $ 608 $ 451 $ 416 $ 466 502
Mailing list size............................. 397 1,300 2,518 4,177 4,792
(1) Operating results in 1997 and 1998 reflect the effects of acquisitions of
ComputAbility, Ltd., and Elek-Tek, Inc. in August 1997 and October 1997,
respectively. See Note 9 of Notes to Consolidated Financial Statements.
(2) Earnings (loss) per share and weighted average shares outstanding have been
restated for all periods presented to reflect the adoption of SFAS 128,
"Earnings per Share." See Note 1 of Notes to Consolidated Financial
Statements.
26
December 31,
---------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
Balance Sheet Data
(in thousands):
Working capital $ 161 $ 46,307 $ 42,600 $ 29,544 $ 42,805
Total assets $42,942 $112,569 $113,431 $131,154 $158,266
Short-term debt $ 4,190 $ 281 $ 283 $ 10,186 $ 122
Long-term debt, excluding current portion $ 1,878 $ 589 $ 325 $ 496 $ 161
Subordinated debt $ 2,950 $ -- $ -- $ -- $ --
Stockholders' equity $ 890 $ 56,560 $ 52,805 $ 59,770 $ 67,564
The information pertaining to uBid's selected financial data is incorporated
by reference to uBid's 1998 10-K in Part II, Item 6.
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. The showrooms and mail-order
operations primarily offered Commodore Amiga personal computers and related
products. After opening its first retail store, the Company conducted mail
order operations from one of its retail showroom locations. The Company became
an authorized Apple dealer in 1991, opened two additional retail computer
showrooms in the second quarter of 1993 and relocated and expanded an existing
showroom in the fourth quarter of 1993. Net sales from the Company's retail
computer showrooms as a percentage of net sales were 13.0%, 12.4% and 6.3% in
1996, 1997 and 1998 respectively. 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.
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 1994, the Company mailed
five editions of its MacMall catalog with a total circulation of approximately
7.7 million to previous and potential customers. During 1995, the Company
distributed ten editions of its MacMall catalog with a total MacMall circulation
of approximately 27.3 million. In 1996, total MacMall circulation increased to
30.3 million with thirteen editions. In 1997, total MacMall circulation
increased to 36.0 million with fourteen editions. In 1998, total MacMall
circulation decreased to 33.0 million with fourteen editions.
In May 1995, the Company distributed its first PC Mall catalog focusing on
the WINTEL personal computer market. During 1995, the Company distributed seven
PC Mall catalogs to approximately 11.1 million previous and prospective
customers. In 1996, the Company distributed thirteen PC Mall catalogs with a
total circulation of 15.3 million. In 1997, total PC Mall circulation was 21.9
million with fourteen editions. In 1998, total PC Mall circulation was 25.8
million with fourteen editions. In September 1997, the Company distributed its
first ComputAbility
27
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.
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 87.0%, 87.6% and 86.7% in 1996, 1997 and 1998, respectively, with average
order size being $416, $466 and $502 for those respective years.
Net sales of the Company are derived primarily from the sale of personal
computer hardware, software, peripherals and accessories 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 advertising on the
Internet. 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 30.1%, 21.4% and 20.0%
of the Company's net sales in 1996, 1997 and 1998, 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. There can be no assurance that trends in sales growth
or operating results will continue in the future.
Percentage of Net Sales
--------------------------
Year Ended December 31,
--------------------------
1996 1997 1998
------- ------- ------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 88.8 87.2 89.3
----- ----- -----
Gross profit 11.2 12.8 10.7
Selling, general and administrative expenses 13.6 11.6 12.4
Expenses related to retail store closure --- --- 1.0
----- ----- -----
Income (loss) before uBid stock-based compensation (2.4) 1.2 (2.7)
uBid stock-based compensation --- --- 0.7
Interest (income) expense, net (0.1) --- 0.1
----- ----- -----
Income (loss) before income taxes (2.3) 1.2 (3.5)
Income taxes (benefit) (0.9) 0.4 (0.7)
----- ----- -----
Income (loss) before minority interest (1.4) 0.8 (2.8)
Minority interest --- --- 0.2
----- ----- -----
Net income (loss) (1.4)% 0.8% (2.6)%
===== ===== =====
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Net sales for the year ended December 31, 1998 were $690.2 million, an
increase of $144.1 million or 26% over net sales for the year ended December 31,
1997 of $546.1 million. Mail order/catalog sales for 1998 were $598.4 million,
an increase of $120.1 million or 25% over 1997 mail order/catalog sales of
$478.3 million. The increase in mail/order catalog sales was primarily due to
an increase in WINTEL sales partially offset by a decrease in MAC sales.
28
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. Retail net sales in 1998 were $43.6 million, a
decrease of $24.2 million or 36% due to the closure of seven of the Company's
stores in the first quarter of 1998. WINTEL net sales increased 65% to $364.6
million in 1998, versus $221.3 million in 1997. uBid's first auction took place
in December 1997 and had revenue of $9 thousand in 1997. uBid sales in 1998 were
$48.2 million on a registered user base of 229,000.
Gross profit for the year ended December 31, 1998 was $74.0 million, an
increase of $3.9 million or 6% from gross profit of $70.1 million for the year
ended December 31, 1997. The increase 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 10.7% in 1998, versus 12.8% in 1997. The
decrease in gross profit percentage was primarily due to the first quarter
write-offs as well as the ramp-up of lower margin sales by uBid.
Selling, general and administrative expenses (SG&A) were $85.5 million for
the year ended December 31, 1998, an increase of $22.0 million or 35% over SG&A
expenses of $63.5 million for the year ended December 31, 1997. As a percentage
of net sales, SG&A expenses were 12.4% in 1998, versus 11.6% in 1997. The
increase is primarily due to the ramp-up of uBid, 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.
Interest expense (income) was $0.5 million for the year ended December 31,
1998 compared with $(0.1) million 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 $2.5 million for the year ended December 31, 1997. The
effective tax rate for 1998 decreased to (21.0%) from 38.0% in 1997. The
decrease in effective tax rate is primarily due to the loss recorded in 1998,
net of a valuation allowance against uBid's 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 $57.9 million, $67.8 million and $43.6 million for the
years ended December 31, 1996, 1997 and 1998, representing 13.0%, 12.4% and 6.3%
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.
Beginning in October 1997, uBid granted stock options to attract and retain
key employees. These options were exercisable only in the event of a successful
initial public offering or sale of uBid. Accordingly, the Company recorded a
$5.3 million non-cash charge to compensation upon the consummation of uBid's
initial public offering in December 1998. uBid expects to record additional
non-cash compensation charges of approximately $8.0 million over the remaining
vesting period of such options.
29
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Net sales for the year ended December 31, 1997 were $546.1 million, an
increase of $101.1 million or 23% over net sales for the year ended December 31,
1996 of $445.0 million. Mail order/catalog sales for 1997 were $478.3 million,
an increase of $91.2 million or 24% over 1996 mail order/catalog sales of $387.1
million. The increase in net sales was primarily due to an increase in the
number of catalogs distributed during the year, the growth from the PC Mall
catalog, an increase in telemarketing sales executives and $37 million in sales
from the two acquisitions in the third and fourth quarters of 1997. The Company
distributed approximately 62.2 million catalogs during 1997, of which MacMall
comprised 36.0 million, PC Mall 21.9 million, DataCom Mall 2.9 million and
ComputAbility 1.4 million. This compared to 48.8 million catalogs distributed
in 1996. Retail net sales in 1997 were $67.8 million, an increase of $9.9
million or 17% from retail net sales of $57.9 million in 1996. WINTEL net sales
increased 116% to $221.3 million in 1997, versus $102.4 million in 1996. WINTEL
net sales for 1997 comprised 40.5% of total net sales as compared to 23.0% in
1996. By December 1997, WINTEL net sales comprised 51.8% of total Company net
sales.
Gross profit for the year ended December 31, 1997 was $70.1 million, an
increase of $20.1 million or 40% from gross profit of $50.0 million for the year
ended December 31, 1996. Gross profit as a percentage of net sales was 12.8% in
1997, versus 11.2% in 1996. The increase in gross profit was primarily due to
the increase in sales in 1997 over 1996 and the large write-downs in 1996 for
slow-moving and excessive inventory, products returned to vendors for which the
Company did not receive payment, and for theft and shrinkage of inventory.
Selling, general and administrative (SG&A) expenses were $63.5 million for
the year ended December 31, 1997, an increase of $2.9 million or 5% over SG&A
expenses of $60.6 million for the year ended December 31, 1996. As a percentage
of net sales, SG&A expenses were 11.6% in 1997, versus 13.6% in 1996. This
decrease is primarily due to write-offs in 1996 associated with the allowance
for doubtful accounts, credit card fraud and significantly lower net advertising
costs in 1997.
In the fourth quarter of 1997, the Company incurred approximately $0.8
million in expenses associated with the relocation and consolidation of its
headquarters and telemarketing operations into a 160,000 square foot building in
a nearby location in Torrance, CA. The Company is phasing into the facility
over two years and initially occupied 60,000 square feet. The Company currently
occupies approximately 98,000 square feet at the Torrance facility.
The Company expensed $1.5 million of non-recurring charges associated with
the Elek-Tek acquisition in the fourth quarter of 1997. These acquisition
related expenses were primarily associated with integrating Elek-Tek's sales
force and customer base into Creative Computers.
Interest income (net of interest expense) was $0.1 million in 1997 compared
to $0.6 million in 1996. The reduction in interest income resulted from cash
outlays and increased borrowings for the acquisitions of ComputAbility and
Elek-Tek.
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. On December 9, 1998, uBid completed an
initial public offering which resulted in net proceeds of $23.8 million. Cash
flows from operations were $(7.8) million, $18.8 million and $13.5 million for
1996, 1997
30
and 1998, respectively. Cash flows from operations in 1998 were favorable due to
improved management of inventory and payables. Cash flows from operations in
1997 were favorable due to improved management of inventory as well as a return
to profitability. Cash flows from operations in 1996 were negative primarily due
to investments in inventory and accounts receivable necessitated by the rapid
sales growth of the Company, including those associated with the introduction of
the Company's MacMall, PC Mall and DataCom Mall catalogs.
Inventory increased $5.3 million in 1998 as more inventory was required to
support the increase in sales. Inventory turns continued to improve from 1997
and 1996. Accounts receivable decreased $2.7 million during 1998, primarily due
to improved collection efforts.
During the year ended December 31, 1998, the Company's capital expenditures
were $3.6 million as compared to $3.3 million in 1997. The Company's primary
capital needs will continue to be funding its working capital requirements for
anticipated sales growth and possible acquisitions.
On August 29, 1997, the Company acquired the assets and liabilities of
ComputAbility Ltd. for $5.5 million cash and 271,739 shares of the Company's
Common Stock.
As of December 31, 1998, the Company had advances outstanding of $38.0
million under a $60 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, total advances and floorplan
financing cannot exceed $60.0 million. The advances outstanding at December 31,
1998 relate to floorplan inventory financing to purchase inventory which is
included in accounts payable. There were no outstanding working capital advances
at December 31,1998. 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 (7.75% and 8.25% per annum at
December 31, 1998 and 1997, 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% (9.75% and 10.25% per annum at
December 31, 1998 and 1997, 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, 1998, the Company was in compliance with these covenants. At
December 31, 1998, the Company had $22.0 million available for working capital
advances and floorplan inventory financing.
On October 15, 1997, the Company borrowed $20.7 million from the credit line
and paid $8.7 million from its cash reserves to purchase the assets of Elek-Tek
for $29.4 million. As of December 31, 1998, the Company has repaid all funds
borrowed to purchase Elek-Tek.
At December 31, 1998, the Company had cash and short-term investments of
$32.5 million and working capital of $42.8 million. 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 1999. 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
31
finance the repurchase plan with existing working capital. As of December 31,
1998, the Company has repurchased 15,000 shares.
As part of its growth strategy, the Company may, in the future, acquire other
companies in the same or complementary lines of business. Any such acquisition
and the ensuing integration of the operations of the acquired company 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.
Year 2000
Computer systems, software packages, and microprocessor dependent equipment
may cease to function or generate erroneous data when the year 2000 arrives.
The problem affects those systems or products that are programmed to accept a
two-digit code in date code fields. To correctly identify the year 2000, a
four-digit date code field will be required to be what is commonly termed "year
2000 compliant."
The Company may realize exposure and risk if the systems for which it is
dependent upon to conduct day-to-day operations are not year 2000 compliant.
The potential areas of exposure include electronic data exchange systems
operated by third parties with whom the Company transacts business, certain
products purchased from third parties for resale, and computers, software,
telephone systems, and other equipment used internally. To minimize the
potential adverse affects of the year 2000 problem, the Company has established
an internal project team comprised of all functional disciplines. This project
team has begun a three-phase process of identifying internal systems (both
information technology and non-information technology systems) not year 2000
compliant, determining their significance in the effective operation of the
Company, and developing plans to resolve the issues where necessary. The Company
has been communicating with the suppliers and others to coordinate year 2000
readiness. The responses received by the Company to date have indicated that
steps are currently being undertaken to address this concern. However, if such
third parties are not able to make all systems and products year 2000 compliant,
there could be a material adverse impact on the Company.
Initial review of the Company's principal application software through which
nearly all of the Company's business is transacted, has determined it to be year
2000 compliant and, as such, the Company does not anticipate any material
adverse operational issues to arise. The Company has completed 75% of the year
2000 compliance assessment for critical systems and will complete its assessment
by the end of the second quarter of 1999. The Company plans to implement
corrective solutions before the end of the third quarter of 1999. To date, the
costs incurred by the Company with respect to this project are $0.1 million.
Based on current estimates, management expects that the Company's total costs in
connection with its year 2000 compliance project will be approximately $0.8
million and will be financed from general corporate funds; however, future
anticipated costs are difficult to estimate with any certainty and may differ
materially from those currently projected based on the results of the assessment
phase of the Company's year 2000 project. The anticipated costs associated with
the Company's year 2000 compliance program do not include time and costs that
may be incurred as a result of any potential failure of third parties to become
year 2000 compliant or costs to implement the Company's future contingency
plans. Management estimates that approximately one half of the expected costs
will be attributed to the redeployment of internal resources and the other half
will be comprised principally of external consulting fees and software upgrades.
No hardware expenditures for year 2000 are contemplated. The redeployment of
internal data processing resources is not expected to materially delay any
significant projects. Year 2000 spending is expected to be 10% of total budgeted
data processing expenditures. The Company has not yet developed a contingency
plan in the event that any non-compliant critical systems are not remedied by
January 1, 2000, nor has it formulated a timetable to create such contingency
plan. Upon completion of this project, if systems material to the Company's
operations have not been made
32
year 2000 compliant, or if third parties fail to make their systems year 2000
compliant in a timely manner, the year 2000 issue could have a material adverse
effect on the Company's business, financial condition and results of operations.
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.
The Management's Discussion and Analysis Of Financial Condition and Results
of Operations of uBid is contained in the uBid 1998 10-K in Part II, Item 7 and
is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and long-term debt. At
March 26, 1999, 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 26,
1999.
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.
uBid's financial statements and supplementary data are contained in Part II,
Item 8 of the uBid 1998 10-K and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
33
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 1999 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. Effective March 1998, the Company accepted
Al S. Joseph's resignation as a director of the Company. Effective December
1999, the Company accepted Ahmed Alfi's resignation as a director of the
Company.
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 1999 Annual Meeting of Stockholders and such
information is incorporated herein by reference.
The information pertaining to the compensation of uBid's executives is
incorporated by reference to uBid's definitive proxy statement for uBid's 1999
annual meeting of stockholders.
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 1999
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 Relationship and
Related Transactions and Compensation Committee Interlocks and Insider
Participation" in the Company's definitive Proxy Statement to be filed in
connection with its 1999 Annual Meeting of Stockholders and such information is
incorporated herein by reference.
34
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)
10.13 Warrant to Purchase Common Stock of Creative Computers, Inc.
dated September 29, 1994 in favor of Creative Partners, L.P. (1)
10.14 Security Agreement dated as of September 26, 1994 by Creative
Computers, Inc. in favor of Creative Partners, L.P. (1)
10.18* Form of Directors' Non-Qualified Stock Option Plan (1)
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)
35
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)
10.35 Separation and Distribution Agreement by and between Creative
Computers, Inc. and uBid, Inc., dated as of December 7, 1998.
(6)
10.36 Services Agreement by and between Creative Computers, Inc. and
uBid, Inc., dated as of December 7, 1998 (6)
10.37 Tax Indemnification and Allocation Agreement by and between
Creative Computers, Inc. and uBid, Inc., dated as of December 7,
1998, as amended (7)
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* Employment Agreement dated January 21, 1999, between
Creative Computers, Inc. and S. Keating Rhoads
21.1 Subsidiaries (2)
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Ernst & Young LLP
27.1 Financial Data Schedule (filed with EDGAR version only)
99.1 uBid, Inc. Form 10-K for the year ended December 31, 1998
(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 uBid, Inc. Form 10-K for the
year ended December 31, 1998, filed with the Commission on
March 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 by the Company during the period
covered by this Report.
The information pertaining to uBid's exhibits, financial statement schedules,
and reports on Form 8-K is incorporated by reference to Part IV, Item 14 of
uBid's 1998 10-K.
36
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 31, 1999.
CREATIVE COMPUTERS, INC.
By: /s/ FRANK F. KHULUSI
-------------------------------------
Frank F. Khulusi
President and 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 31, 1999
- -------------------------- Directors, President and
Frank F. Khulusi Chief Executive Officer
(Principal Executive Officer)
/s/ THEODORE R. SANDERS Chief Financial Officer March 31, 1999
- -------------------------- (Principal Financial and
Theodore R. Sanders Accounting Officer)
/s/ SAM U. KHULUSI Director March 31, 1999
- --------------------------
Sam U. Khulusi
/s/ THOMAS MALOOF Director March 31, 1999
- --------------------------
Thomas Maloof
37
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, 1998 and 1997 F-3
Consolidated Statement of Operations for the Years Ended
December 31, 1998, 1997 and 1996 F-4
Consolidated Statement of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statement of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
Quarterly Financial Information (unaudited) F-20
Financial Statement Schedules
- -----------------------------
Schedule II -- Valuation and Qualifying Accounts F-21
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 on page F-1
present fairly, in all material respects, the financial position of Creative
Computers, Inc. and its subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of uBid, Inc., a majority-owned subsidiary, for the year ended
December 31, 1998, which statements reflect total assets of $34,625,000 at
December 31, 1998 and total revenues of $48,232,000 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., is based solely on the report of the other
auditors. We conducted our audits of the consolidated financial statements in
accordance with generally accepted auditing standards 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 3, 1999
F-2
CREATIVE COMPUTERS, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
December 31,
--------------------
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 32,495 $ 8,018
Accounts receivable, net of allowance for
doubtful accounts of $3,697 and $2,859, respectively 39,775 42,455
Inventories 47,971 42,643
Prepaid expenses and other current assets 3,991 2,894
Income tax refund receivable 190 469
Deferred income taxes 5,216 2,484
-------- --------
Total current assets 129,638 98,963
-------- --------
Property, plant and equipment, net 14,910 16,868
Goodwill, net 12,318 15,141
Deferred income taxes 1,262 -
Other assets 138 182
-------- --------
$158,266 $131,154
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 71,142 $ 45,958
Accrued expenses and other current liabilities 15,569 13,275
Line of credit - 9,956
Capital leases--current portion 116 207
Notes payable--current portion 6 23
-------- --------
Total current liabilities 86,833 69,419
-------- --------
Capital leases 6 148
Notes payable 155 348
Deferred income taxes - 1,469
-------- --------
Total liabilities 86,994 71,384
Minority Interest 3,708 -
Stockholders' equity:
Common stock, $.001 par value; authorized 15,000,000
shares; 10,264,539 and 10,105,258 shares issued
and outstanding 10 10
Preferred stock, $.001 par value; authorized 5,000,000 shares;
none issued and outstanding
Additional paid-in capital 82,361 56,772
Treasury stock, at cost: 15,000 shares (91) (91)
Retained earnings (accumulated deficit) (14,716) 3,079
-------- --------
Total stockholders' equity 67,564 59,770
-------- --------
$158,266 $131,154
======== ========
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,
-------------------------------
1998 1997 1996
-------- -------- --------
Net sales $690,238 $546,131 $444,971
Cost of goods sold 612,566 476,061 395,000
Retail store closure inventory reserve 3,679 - -
-------- -------- --------
Gross profit 73,993 70,070 49,971
Selling, general and administrative
expenses 85,519 63,540 60,585
Expenses related to retail store closures 6,773 - -
-------- -------- --------
Income (loss) before uBid stock-based
compensation (18,299) 6,530 (10,614)
uBid stock-based compensation 5,267 - -
-------- -------- --------
Income (loss) from operations (23,566) 6,530 (10,614)
Interest income (expense), net (461) 118 593
-------- -------- --------
Income (loss) before income taxes (24,027) 6,648 (10,021)
Income tax provision (benefit) (5,034) 2,523 (3,972)
-------- -------- --------
Income (loss) before minority interest (18,993) 4,125 (6,049)
Minority interest 1,198 - -
-------- -------- --------
Net income (loss) $(17,795) $ 4,125 $ (6,049)
======== ======== ========
Basic earnings (loss) per share $(1.75) $0.42 $(0.62)
======== ======== ========
Diluted earnings (loss) per share $(1.75) $0.41 $(0.62)
======== ======== ========
Basic weighted average number of
shares outstanding 10,176 9,895 9,767
======== ======== ========
Diluted weighted average number of
shares outstanding 10,176 10,030 9,767
======== ======== ========
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, 1995 9,750 $10 $51,547 5,003 $ $ 56,560
Purchase of treasury stock (91) (91)
Stock option exercises 42 239 239
Contribution from director 2,146 2,146
Net loss (6,049) (6,049)
------ --- ------- -------- ---- --------
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
====== === ======= ======== ==== ========
See accompanying notes to consolidated financial statements.
F-5
CREATIVE COMPUTERS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Year ended December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
Cash flows from operating activities:
Net income (loss) $(17,795) $ 4,125 $ (6,049)
-------- -------- --------
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,033 2,337 1,955
Provision (benefit) for deferred income taxes (5,017) 2,350 (3,010)
Loss on disposal of property, plant and equipment 1,950 783 -
Loss on impairment of goodwill 3,095 - -
uBid non-cash stock-based compensation charge 5,267 - -
Minority interest (1,198) - -
Changes in assets and liabilities, net of acquisitions:
Accounts receivable 2,680 (5,112) (1,643)
Inventories (5,328) 17,414 (3,066)
Prepaid expenses and other current assets (1,158) 906 27
Other assets (742) 3 242
Accounts payable 25,184 (6,827) 4,164
Accrued expenses and other current liabilities 2,294 1,064 550
Income tax refund receivable 279 1,723 (959)
-------- -------- --------
Total adjustments 31,339 14,641 (1,740)
-------- -------- --------
Net cash provided by (used in) operating activities 13,544 18,766 (7,789)
-------- -------- --------
Cash flows from investing activities:
Redemptions of securities available for sale - 1,536 31,805
Purchase of securities available for sale - (1,015) (19,751)
Acquisition of Elek-Tek - (9,083) -
Acquisition of ComputAbility - (5,482) -
Acquisition of property, plant and equipment (3,552) (3,276) (2,050)
Proceeds from sale of equipment - 13 -
-------- -------- --------
Net cash (used in) provided by investing activities (3,552) (17,307) 10,004
-------- -------- --------
Cash flows from financing activities:
Net line of credit payments (9,956) (10,775) -
Payments under notes payable (210) (81) (13)
Proceeds from profits realized by Director on sale of stock - - 2,146
Principal payments of obligations under capital leases (233) (254) (249)
Purchase of treasury stock - - (91)
Net proceeds of uBid initial public offering 23,847 - -
Proceeds from stock issued under stock option plans 1,037 340 239
-------- -------- --------
Net cash provided by (used in) financing activities 14,485 (10,770) 2,032
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 24,477 (9,311) 4,247
Cash and cash equivalents:
Beginning of year 8,018 17,329 13,082
-------- -------- --------
End of year $ 32,495 $ 8,018 $ 17,329
======== ======== ========
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. 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 advertising on the Internet. 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 websites 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. At December 31, 1998,
the Company owned approximately 80.1% of the outstanding shares of common stock
of uBid. The Company intends to distribute to shareholders, subject to the
satisfaction of certain conditions, its ownership in uBid by means of a tax-free
stock dividend in 1999, but in no event prior to 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
Revenue on product sales is recognized at the time of shipment. The
Company's return policy varies from product to product, and in some cases
provides a money-back guarantee. An allowance for potential product returns is
established based upon historical trends.
Cash Equivalents
All highly liquid investments with initial maturities of three months or
less are considered cash equivalents.
F-7
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Inventories
Inventories consist of computer hardware, software and peripheral products,
and are stated at cost (determined under the first-in, first-out cost method) or
market, whichever is lower. At December 31, 1998 and 1997, the Company had
reserves of $5,036 and $5,364, 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 $6,816, $1,397 and $8,155 in 1998, 1997, and 1996,
respectively. Deferred advertising costs were $3,106 and $2,105 at December 31,
1998 and 1997, 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
Computer, machinery and equipment 3 - 7 years
Building 31.5 years
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 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, 1998 and 1997
was $604 and $90, respectively. Amortization expense totaled $514 and $90 in
1998 and 1997.
F-8
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
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. 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.
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
Effective in the fourth quarter of 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). SFAS
128 requires dual presentation of Basic Earnings (Loss) per Share (Basic EPS)
and Diluted Earnings (Loss) per Share (Diluted EPS). 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. Earnings (loss) per share has been restated for all periods to reflect
the adoption of SFAS 128.
The composition of Basic and Diluted EPS is as follows:
Year ended December 31,
---------------------------------------
1998 1997 1996
------------ ----------- ----------
Net income (loss) $ (17,795) $ 4,125 $ (6,049)
=========== =========== ==========
Weighted average shares - Basic 10,175,864 9,895,179 9,766,863
Effect of dilutive stock options
and warrants - 135,328 -
----------- ----------- ----------
Weighted average shares - Diluted 10,175,864 10,030,417 9,766,863
=========== =========== ==========
Net income (loss) per share - Basic $ (1.75) $ 0.42 $ (0.62)
=========== =========== ==========
Net income (loss) per share - Diluted $ (1.75) $ 0.41 $ (0.62)
=========== =========== ==========
F-9
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
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.
New Accounting Standards
During 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosure about Segments of an Enterprise and Related
Information" (SFAS 131). The adoption of this statement did not have a material
effect on the Company's consolidated financial statements, and the appropriate
disclosures required by this statement have been incorporated herein.
Reclassifications
Certain reclassifications have been made to the 1996 and 1997 financial
statement balances to conform to the 1998 presentation.
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following as of December 31:
1998 1997
-------- --------
Furniture and fixtures $ 2,370 $ 2,907
Leasehold improvements 2,703 3,483
Computer, machinery and equipment 15,152 12,337
Building 2,827 2,827
Land 1,446 1,446
------- -------
24,498 23,000
Less: Accumulated depreciation and amortization (9,588) (6,132)
------- -------
$14,910 $16,868
======= =======
The Company leases certain equipment under capital leases. The following
is a summary of such equipment as of December 31:
1998 1997
-------- --------
Computer, machinery and equipment $ 454 $ 1,705
Furniture and fixtures 119 372
----- -------
573 2,077
Less: Accumulated amortization (472) (1,660)
----- -------
$ 101 $ 417
===== =======
F-10
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
3. Line of credit
As of December 31, 1998, the Company had advances outstanding of $37,971
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, 1998 relate to floorplan
inventory financing to purchase inventory which is included in accounts payable.
There were no outstanding working capital advances at December 31,1998. 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 (7.75% and 8.25% per annum at December 31, 1998 and 1997, 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%
(9.75% and 10.25% per annum at December 31, 1998 and 1997, 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, 1998, the Company was in compliance with
these covenants. At December 31, 1998, the Company had $22,029 available for
working capital advances and floorplan inventory financing.
As of December 31, 1997, the Company had advances of $16,340 comprised of
$9,956 of working capital loans borrowed in connection with the acquisition of
Elek-Tek, and $6,384 of floorplan inventory financing to purchase inventory,
which is included in accounts payable.
4. Income Taxes
The provision (benefit) for income taxes consists of the following for the
years ended December 31:
1998 1997 1996
-------- ------ --------
Current
Federal $ (100) $ 103 $(1,011)
State 83 70 49
------- ------ -------
(17) 173 (962)
------- ------ -------
Deferred
Federal (4,584) 2,101 (2,514)
State (433) 249 (496)
------- ------ -------
(5,017) 2,350 (3,010)
------- ------ -------
$(5,034) $2,523 $(3,972)
======= ====== =======
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:
1998 1997 1996
------- ------ -------
Expected taxes at federal
statutory tax rate (34.0)% 34.0 % (34.0)%
State income taxes, net of federal
income tax benefit (2.7)% 5.0 % (4.6)
Change in valuation allowance 14.5 % -- --
Other 1.2 % (1.0)% (1.0)
----- ----- ------
(21.0)% 38.0 % (39.6)%
====== ===== ======
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:
1998 1997
-------- --------
Accounts receivable $ 1,445 $ 530
Inventories 849 1,326
Property, plant and equipment (1,190) (1,222)
Amortization (396) (340)
Accrued expenses and reserves 642 529
Stock options 1,559 --
Tax credits and loss carryforwards 6,885 143
Other 3 49
Less: Valuation allowance (3,319) --
------- -------
Net deferred tax assets $ 6,478 $ 1,015
======= =======
At December 31, 1998, the Company had federal net operating loss
carryforwards of $18,185, which begin to expire in 2018. At December 31, 1998,
the Company had various state net operating loss carryforwards ranging in
amounts from $1,296 to $3,463, which begin to expire in 2002. At December 31,
1998, the Company had federal and state capital loss carryforwards of $71, which
begin to expire in 2001. The Company also had state tax credit carryforwards of
$101, which begin to expire in 2011.
5. Commitments and Contingencies
Leases
The Company occupies office and warehouse space under various operating
leases with independent parties 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, 1998 were as follows:
1999 $2,148
2000 2,368
2001 2,333
2002 1,689
------
Total $8,538
======
In 1998, 1997 and 1996 rent expense was $2,486, $1,978 and $1,408,
respectively. Some of the leases contain renewal options, 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
F-12
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
6. Stockholders' Equity
Initial Public Offering of uBid, Inc.
On December 9, 1998, uBid, Inc., a subsidiary of the Company, 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, and will
be used for advertising and brand development of uBid's infrastructure to
support growth, and for uBid's general corporate purposes. The shares sold to
the public in the offering represent approximately 19.9% of uBid's outstanding
common stock. The Company will continue to own the remaining 80.1% of uBid but
intends to distribute, subject to the satisfaction of certain conditions, its
ownership in uBid by means of a tax-free stock dividend to the Company's
stockholders in 1999, but in no event prior to June 7, 1999. 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.
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, 1998, the Company has
repurchased 15,000 shares.
Proceeds from Profits Realized by Director in the Sale of Stock
In June 1996, the Company recorded additional paid-in capital in the amount
of $2,146, net of expenses, which represents cash contributed to the Company
associated with profits realized in the sale of stock by one of the Company's
directors pursuant to Section 16(b) of the Securities Exchange Act of 1934.
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 1998, 1997 and 1996, the Company incurred $87, $84
and $66, respectively, of expenses related to the 401(k) matching component of
this plan.
F-13
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
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 of 1986, or options not
intended to qualify as Incentive Stock Options ("Nonstatutory Stock Options").
A total of 1,950,000 shares of common stock have been reserved for issuance upon
the exercise of options granted under the 1994 Plan. As of December 31, 1998,
802,847 shares of authorized but unissued common stock are available for future
grants under the 1994 Plan. All options granted through December 31, 1998 have
been Nonstatutory Stock Options.
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. A total of 50,000 shares of Common Stock are reserved
for issuance under the Director Plan of which options to purchase 31,000 shares
are outstanding as of December 31, 1998.
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.
F-14
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The following table summarizes stock option activity:
Weighted
Average
Number Exercise Price
------ --------------
Outstanding at December 31, 1995 480,560 $17.60
Granted 576,200 8.51
Canceled (294,221) 9.00
Exercised (41,825) 5.66
--------
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
========
On February 12, 1996, the Compensation Committee of the Board of Directors
repriced all stock options granted from April 15, 1995 through February 12, 1996
to the closing price for the day of $9.50. On Saturday July 27, 1996, the
Compensation Committee of the Board of Directors repriced all stock options
(with exercise prices in excess of $6.00 per share) to $6.00 per share. The
closing price per share on July 26, 1996 was $5.25.
Of the options outstanding at December 31, 1998, 1997 and 1996, options to
purchase 306,483, 274,914 and 144,531 shares were exercisable at weighted
average prices of $6.41, $6.21 and $5.85 per share, respectively. The following
table summarizes information concerning currently outstanding and exercisable
stock options:
Options exercisable at
Options Outstanding at December 31, 1998 December 31, 1998
----------------------------------------------- ---------------------------
Weighted- Weighted- Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding Contractual Life Price Exercisable Price
- -------------------------- ----------------------------------------------- ---------------------------
$5.00 - $6.00 305,151 6.92 $ 5.82 212,286 $5.84
$6.06 - $7.38 346,601 9.09 $ 6.87 64,368 $7.08
$7.50 - $12.94 252,601 9.33 $10.03 29,829 $9.02
------- -------
904,353 306,483
======= =======
F-15
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
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:
1998 1997 1996
------------ ------------- -------------
Risk free interest rates 4.89% 6.34% 6.23%
Expected dividend yield none none none
Expected lives 7 yrs. 6 yrs. 5 yrs.
Expected volatility 100.0% 80.0% 60.0%
The weighted average grant date fair values of options granted under the
Plans during 1998, 1997 and 1996 were $8.43, $5.55 and $2.75, respectively.
uBid Employee Stock Option Plans
uBid has granted non-qualified options to certain employees and directors of
uBid to purchase Common Stock. Each option agreement provides that options may
not be exercised prior to the earlier of (i) the day following the distribution
of all uBid stock held by the Parent to its shareholders or (ii) 18 months from
the closing date of uBid's IPO. Accordingly, no options were exercisable at
December 31, 1998.
The terms of the options provide for vesting, generally over a 5-year period,
except for options to purchase 183,247 shares of common stock at December 31,
1998 which vested as to the first 20% of the shares covered by such options upon
completion of the IPO. The options expire 10 years from the date of grant.
The following table summarizes stock option activity:
Weighted
Average
Number Exercise Price
------ --------------
Granted 458,118 $ 0.27
Canceled -
Exercised -
---------
Outstanding at December 31, 1997 458,118 0.27
Granted 651,725 4.62
Canceled (2,565) 0.27
Exercised -
---------
Outstanding at December 31, 1998 1,107,278 2.79
=========
The options outstanding at December 31, 1997 all have an exercise price of
$0.27. Of the options granted during the year ended December 31, 1998, options
to purchase 370,526, 18,325, 109,948, 1,832, 79,529 and 69,000 common shares are
outstanding, and have exercise prices of $0.27, $6.82, $8.87, $10.20, $11.79 and
$15.00, respectively. Options at December 31, 1998 have a weighted average
estimated remaining life of 5.95 years.
F-16
CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
uBid commenced its IPO on December 4, 1998 causing a measurement date to occur
and requiring the computation of compensation expense based upon the difference
between the exercise price of the options and the IPO price. Based upon the
difference between the IPO price of $15.00 per share and the exercise prices of
the 1,038,278 options outstanding at December 4, 1998, the total compensation
charge will be approximately $13,300, which will be recognized over the vesting
period, approximately $5,300 of which was recognized in December 1998.
The fair value of each stock option grant has been estimated pursuant to SFAS
No. 123 on the date of grant using the minimum value method for those options
granted prior to the IPO, and the Black-Scholes option pricing method for those
options issued concurrent with the IPO, with the following weighted average
assumptions:
Minimum Value Black-Scholes
Assumptions Assumptions
------------- -------------
Risk free interest rate 6.3% 4.89%
Expected dividend yield none none
Expected lives 6 years 6 years
Expected volatility 100% 142%
The weighted average grant date fair values of options granted during the
twelve months ended December 31, 1998 and the period from Inception to
December 31, 1997 were $4.03 and $0.08, respectively.
uBid 1998 Stock Incentive Plan
In August 1998, uBid's Board of Directors adopted the 1998 Stock Incentive
Plan (the "1998 Plan") and reserved 1,832,470 shares of uBid Common Stock for
issuance thereunder. The plan authorized the award of options, stock
appreciation rights, restricted stock awards and performance based stock awards
(each an "Award"). The maximum number of shares with respect to options and
stock appreciation rights granted to any employee in any fiscal year is 476,442
shares. Options granted under the Plan may be either incentive stock options
("ISOs") or non-qualified stock options ("NSOs"). ISOs may be granted only to
employee (including officers and directors who are also employees). Awards
other than ISOs may be granted to employees, directors and consultants, as
defined.
Options under the Plan may be granted for periods up to ten years and at
prices no less than 85% of the fair value of the shares on the date of grant
provided, however, that the exercise price of an ISO may not be less than 100%
of the fair market value of the shares on the date of grant and the exercise
price of an ISO granted to a 10% shareholder may not be less than 110% of the
fair market value of the shares on the date of grant.
There have been no options granted under the 1998 Plan through December 31,
1998.
FAS 123 PRO FORMA INFORMATION
The Company accounts for its 1994 Plan, Director Plan and uBid Employee Stock
Option Plans (the "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.
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CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
Year ended December 31,
------------------------------
1998 1997 1996
-------- -------- --------
Net income (loss) As Reported $(17,795) $4,125 $(6,049)
Pro Forma $(14,094) $3,549 $(7,478)
Diluted net income (loss)
per share As Reported $ (1.75) $ 0.41 $ (0.62)
Pro Forma $ (1.39) $ 0.37 $ (0.77)
8. Supplemental Disclosures of Cash Flow Information
1998 1997 1996
-------- -------- --------
Cash paid during the year ending December 31:
Interest $ 851 $ 488 $ 119
Income taxes $ 281 $ 538 $ 74
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 -- $ 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.
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CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
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 years presented. However, these pro forma
results are not necessarily indicative of the actual results of operations that
would have occurred.
Year ended December 31,
------------------------
1997 1996
----------- ----------
Net sales $791,345 $835,024
Net income (loss) $ 1,046 $(13,391)
Diluted earnings (loss) per share $ 0.10 $ (1.33)
10. Headquarters Move
In November 1997, the Company consolidated its headquarters and
telemarketing facilities into a 160,000 square foot building in Torrance, CA.
The charge associated with the move was $815, and was expensed in the fourth
quarter of 1997. The Company plans to phase in the occupancy of the entire
facility over a two-year period, initially leasing approximately one third of
the building. As of December 31, 1998, the Company leases approximately 60% of
the building.
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. No reserves remain at December 31, 1998 related to the retail
store closures.
12. Segment Information
The Company operates in two business segments in the computer retail
industry: mail order/catalog and Internet auction. The mail order/catalog
segment sells personal computer hardware, software, and peripheral products
through means of catalog distribution, Internet websites, and outbound
telemarketing. Prices are set based on available inventory and market
conditions.
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CREATIVE COMPUTERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share data)
The Internet auction segment offers consumers and small- to medium-sized
businesses excess, refurbished, closeout and limited edition merchandise through
live-action bidding. The segment's Internet auctions feature a rotating
selection of brand name computer, consumer electronics, home/leisure and
sports/fitness products. Prices are determined by the highest bidders.
Summarized segment information for the year ended December 31, 1998 is as
follows:
Mail Order/Catalog Internet Auction Consolidated
------------------- --------------------- ----------------------
Net sales $642,006 $48,232 $690,238
Gross profit(1) 70,018 3,975 73,993
Operating loss(1) (13,567) (9,999) (23,566)
Total assets $123,641 $34,625 $158,266
(1) Gross profit and operating loss include special charges.
Segment information is not provided for the years ended December 31, 1997
and December 31, 1996 as the Company did not operate in the Internet auction
segment until the formation of uBid in November 1997. Results for the year ended
December 31, 1997 for the Internet auction segment were immaterial.
F-20
CREATIVE COMPUTERS, INC.
Quarterly Financial Information (Unaudited)
(in thousands except per-share data)
1998
----------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
---------------- --------------- --------------- ----------------
Net Sales $164,134 $149,934 $185,741 $190,429
Gross Profit 12,577 18,498 21,294 21,624
Net income (loss) (12,809) 212 435 (5,633)
Net earnings (loss) per share
Basic (1.27) 0.02 0.04 (0.55)
Diluted (1.27) 0.02 0.04 (0.55)
1997
----------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------- --------------- --------------- ---------------
Net Sales $120,140 $116,018 $132,236 $177,737
Gross Profit 15,448 14,836 16,902 22,884
Net income 770 760 1,594 1,001
Net earnings per share
Basic 0.08 0.08 0.16 0.10
Diluted 0.08 0.08 0.16 0.10
A discussion of special charges for the year ended December 31, 1998 is
included in Note 7 and Note 11 of the consolidated financial statements.
F-21
SCHEDULE II
CREATIVE COMPUTERS, INC.
Valuation and Qualifying Accounts
For the years ended December 31, 1996, 1997 and 1998
(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, 1996 $1,365 $ 2,041 $ (1,272) $2,134
December 31, 1997 2,134 5,680 (4,955) 2,859
December 31, 1998 2,859 3,948 (3,110) 3,697
Reserve for inventory for the year ended:
December 31, 1996 1,419 6,432 (1,547) 6,304
December 31, 1997 6,304 6,548 (7,488) 5,364
December 31, 1998 5,364 6,468 (6,796) 5,036
Restructuring reserve for the year ended:
December 31, 1998 - 10,452 (10,452) -
Deferred tax asset valuation allowance for the year ended:
December 31, 1998 - 3,319 - 3,319
F-22