<PAGE>
Filed pursuant to Rule 424(b)(4)
Registration No. 333-41171
PROSPECTUS
MARCH 3, 1998
3,125,000 SHARES
LOGO
[LOGO OF PC CONNECTION, INC. APPEARS HERE]
COMMON STOCK
All the shares of Common Stock, $0.01 par value per share (the "Common
Stock"), offered hereby (the "Offering") are being sold by PC Connection, Inc.
("PC Connection" or the "Company").
Prior to the Offering, there has been no public market for the Common Stock
of the Company. See "Underwriting" for information relating to the factors
considered in determining the initial price to the public.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "PCCC."
SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<TABLE>
- --------------------------------------------------------------------------------
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO THE DISCOUNTS AND TO THE
PUBLIC COMMISSIONS(1) COMPANY(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................ $17.50 $1.225 $16.275
Total(3)................................. $54,687,500 $3,828,125 $50,859,375
- --------------------------------------------------------------------------------
</TABLE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting" for indemnification arrangements with the
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $950,000.
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to an aggregate of 468,750 additional shares at the Price to the Public,
less Underwriting Discounts and Commissions, solely to cover over-
allotments, if any. If the option is exercised in full, the total Price to
the Public, Underwriting Discounts and Commissions and Proceeds to the
Company will be $62,890,625, $4,402,344 and $58,488,281, respectively. See
"Underwriting."
The shares of Common Stock are being offered by the several Underwriters
subject to prior sale, when, as and if issued and accepted by them, subject to
certain prior conditions, including the right of the Underwriters to reject
any order in whole or in part. It is expected that delivery of the shares of
Common Stock will be made in New York, New York on or about March 6, 1998.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATIONSBANC MONTGOMERY SECURITIES LLC
WILLIAM BLAIR & COMPANY
<PAGE>
INSIDE FRONT COVER
- ------------------
FIRST PAGE OF INSIDE COVER:
- ---------------------------
[ACROSS THE TOP OF THE PAGE:
PICTURE OF THE RACCOON CHARACTER(R) WITH AWARDS AROUND ITS NECK TO THE
LEFT AND THE TEXT "PC CONNECTION YOUR SOURCE FOR COMPUTERS, SOFTWARE
AND PERIPHERALS SINCE 1982"]
[IN CENTER OF PAGE:
PICTURES FROM LEFT TO RIGHT OF THE PC CONNECTION CATALOG, THE PC
CONNECTION INTERNET WEB PAGE AND THE MACCONNECTION CATALOG.]
[AT THE BOTTOM LEFT OF THE PAGE:
7-TIME WINNER BEST MAIL-ORDER COMPANY
1997 PC WORLD WORLD CLASS LOGO
1990, 1991, 1992, 1994, 1995, 1996 & 1997]
[AT THE BOTTOM RIGHT OF THE PAGE:
THE PC MAGAZINE 100 LOGO
FIRST RESELLER LISTED IN PC MAGAZINE'S "100 MOST INFLUENTIAL COMPANIES
OF 1997"]
GATEFOLD:
- ---------
[AT THE TOP LEFT OF THE GATEFOLD:
PICTURE OF THE PC CONNECTION CATALOG COVER PAGE AND TWO PICTURES OF THE
CATALOG OPENED.
CAPTION: COLORFUL CATALOGS FEATURING PRODUCTS FROM COMPAQ, HEWLETT
PACKARD, TOSHIBA, IBM, MICROSOFT, SONY, HITACHI, APPLE AND
MANY OTHERS.]
[AT THE TOP RIGHT OF THE GATEFOLD:
PICTURE OF THE PC CONNECTION INTERNET WEB SITE.
CAPTION: ONLINE SUPERSTORE OFFERS ONLINE ORDERING FOR MORE THAN 15,000
PRODUCTS. FEATURES MANUFACTURER HOTLINKS, A PRODUCT SEARCH
ENGINE, AND ONLINE TECHNICAL SUPPORT. WWW.PCCONNECTION.COM]
[CENTER OF THE GATEFOLD:
PC CONNECTION(R) ACROSS THE PAGE]
[AT THE BOTTOM LEFT OF THE GATEFOLD:
PICTURE ABOVE OF A PERSON SERVICING A COMPUTER.
CAPTION: SERVICE CONNECTION(TM).
TRAINING PROGRAMS FOR OUR SERVICE AND SUPPORT PERSONNEL
EMPHASIZE PUTTING CUSTOMER NEEDS FIRST. THE COMPANY IS OPEN
24-HOURS A DAY, SEVEN DAYS A WEEK TO HANDLE ORDERS AND GENERAL
INQUIRIES.
PICTURE BELOW OF INDIVIDUALS PACKING PRODUCTS TO FILL ORDERS AT THE
DISTRIBUTION CENTER.
CAPTION: EVERYTHING OVERNIGHT(R)
CUSTOMERS CAN PLACE THEIR ORDERS AS LATE AS 2:45 A.M. ET AND
STILL GET OVERNIGHT DELIVERY.]
[AT THE BOTTOM RIGHT OF THE GATEFOLD:
PICTURE ABOVE OF ONE OF THE COMPANY'S TELEMARKETING ACCOUNT MANAGERS AT
HER COMPUTER.
CAPTION: CORPORATE TELEMARKETING ACCOUNT MANAGERS PURSUE BUYERS IN
BUSINESS, GOVERNMENT AND EDUCATION MARKETS.
PICTURE BELOW OF THE RACCOON CHARACTER(R) WITH AWARDS AROUND ITS NECK.
CAPTION: SINCE 1982 PC CONNECTION HAS EMPHASIZED CUSTOMER SERVICE, WITH
PROGRAMS SUCH AS TOLL-FREE TECHNICAL SUPPORT, ONE-MINUTE MAIL
ORDER(R) & EVERYTHING OVERNIGHT(R).]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING
AND MAY BID FOR AND PURCHASE SHARES OF THE COMMON STOCK IN THE OPEN MARKET.
FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information and financial statements, including the notes thereto, appearing
elsewhere in this Prospectus. Unless otherwise indicated, all information in
this Prospectus, other than historical financial statements, gives effect to
the Reorganization (as such term is defined below) and assumes no exercise of
the Underwriters' over-allotment option.
THE COMPANY
PC Connection is a direct marketer of brand-name personal computers and
related peripherals, software, accessories and networking products. The
Company's primary target customers are small and medium-sized organizations
("SMORGS") comprised of 20 to 1,000 employees. PC Connection sells its products
through a combination of targeted direct mail catalogs, outbound telemarketing,
its Internet Web site and advertisements on the Internet and in selected
computer magazines. The Company offers a broad selection of approximately
15,000 products targeted for business use at competitive prices, including
products from Compaq, Hewlett-Packard, Toshiba, IBM, Microsoft, Sony, Hitachi
and Apple. Net sales of Microsoft Windows or MS-DOS based personal computers
("PCs") and compatible products were approximately 78.1% of net sales in 1997.
The Company's most frequently ordered products are carried in inventory and are
typically shipped to customers the same day that the order is received.
The Company has experienced rapid growth in sales, profitability, number of
orders and average order size as a result of: (i) a substantial increase in the
number and assortment of products carried by the Company; (ii) increases in
outbound telemarketing personnel and improvements in productivity; (iii)
increases in catalog circulation; and (iv) improvements in inbound
telemarketing productivity. The Company recorded net sales of $550.6 million
and income from operations of $7.2 million in 1997, representing increases of
65.2% and 16.6%, respectively, over 1996. Excluding additional
stockholder/officer compensation of $12.1 million (which represented Company-
related federal income tax obligations payable by stockholders under Subchapter
S of the Internal Revenue Code (the "Code")), income from operations was $19.4
million in 1997, representing an increase of 159.4% over the comparable amount
in 1996. The Company recorded net sales of $333.3 million and income from
operations of $6.2 million in 1996, representing increases of 32.2% and 143.9%,
respectively, over 1995. Excluding additional stockholder/officer compensation
of $1.3 million (which represented Company-related federal income tax
obligations payable by stockholders under Subchapter S of the Code), income
from operations was $7.5 million in 1996, representing an increase of 193.4%
over the comparable amount in 1995.
According to industry data published by Merrin Information Services, Inc.
("Merrin") in May 1997, domestic sales of personal computers and related
products were $77.8 billion in 1996 and are projected to be $138.2 billion in
2000, representing a compound annual growth rate of 15.4%. The Company believes
that the direct marketing channel will be among the fastest growing
distribution channels for the domestic personal computer and related products
industry. As a leading participant in the direct marketing channel, the Company
believes it is well positioned to capitalize on the expected growth in the
industry.
The Company's growth strategies are to: (i) increase penetration of its
existing customer base; (ii) broaden its product offerings to include higher
margin products such as network servers and communications equipment; and (iii)
expand its customer base. The Company plans to target a greater number of its
existing customers with outbound telemarketing, more aggressively pursue first-
to-market product offerings, provide specialized offerings to targeted segments
of its customer base and increase its investments in electronic commerce and
Internet related marketing opportunities.
Since its founding in 1982, the Company has focused on serving customer needs
by providing innovative, reliable and timely customer service and technical
support, and offering an extensive assortment of branded products, through
knowledgeable, well-trained sales and support teams. The effectiveness of this
strategy is reflected in the recognition accorded the Company, including the
Company's receipt of the PC World "World Class Award for Best Mail-Order
Company" in 1997, as voted by its readers, for the seventh time in the past
eight years, and receipt of the highest ranking of only two direct resellers
included in the first-ever ranking of the "100 Most Influential Companies in
the Computer Industry" by PC Magazine in July 1997.
3
<PAGE>
The Company believes that its consistent customer focus has also resulted in
the development of strong brand name recognition and a broad and loyal customer
base. At December 31, 1997, the Company's mailing list consisted of
approximately 2,000,000 customers and potential customers, of which
approximately 500,000 had purchased products from the Company within the last
twelve months. Approximately 65% of the Company's net sales in the year ended
December 31, 1997 were made to customers who had previously purchased products
from the Company. The Company believes it has also developed strong
relationships with vendors, resulting in favorable product allocations and
marketing assistance.
Commencing in late 1995, the Company significantly increased its business-to-
business marketing efforts targeting SMORGS, a rapidly growing sector of the
personal computer market that the Company believes is particularly receptive to
purchases from direct marketers. To serve this growing part of its business
more effectively, the Company has increased the number of its outbound
telemarketing account managers from 48 at December 31, 1995 to 155 at December
31, 1997, including 90 new account managers with less than 12 months of
outbound telemarketing experience with the Company. Historically, outbound
account managers become significantly more productive in their second year with
the Company. In addition, in late 1995 the Company initiated programs to
increase training of inbound telemarketing personnel and to provide incentive
compensation based upon sales productivity.
The Company's two major catalogs are PC Connection(R), focused on PCs and
compatible products, and MacConnection(R), focused on Apple Macintosh personal
computers ("Macs") and compatible products. With colorful illustrations,
concise product descriptions, relevant technical information, along with
customer service benefits and toll-free telephone numbers for ordering, the
Company's catalogs are recognized as a leading source for personal computer
hardware, software and other related products. The Company distributed
approximately 34 million catalogs during the year ended December 31, 1997.
The Company also markets its products and services through its Internet Web
site, www.pcconnection.com, which provides customers and prospective customers
with Company and product information and enables customers to place electronic
orders for all of the Company's products. The Company believes that as the
Internet becomes a more important commercial medium, it will be well positioned
to capitalize on growth through this emerging channel.
The Company operates in a competitive industry and there can be no assurance
that the Company will sustain historical growth rates. See "Risk Factors."
The Company has a 102,000-square foot, full-service distribution and order
fulfillment center in Wilmington, Ohio and a related 25,700-square foot
warehouse in Xenia, Ohio. The Company also operates telemarketing centers in
Hudson, Keene and Milford, New Hampshire.
----------------
The Company's principal executive offices are located at 528 Route 13,
Milford, New Hampshire 03055, and its telephone number is (603) 423-2000. The
Company's Internet Web site is located at www.pcconnection.com. Neither the
information contained in the Company's Internet Web site nor Internet Web sites
linked to the Company's Internet Web site shall be deemed to be a part of this
Prospectus.
----------------
PC Connection(R), MacConnection(R), Everything Overnight(R), One-Minute Mail
Order(R) and the Raccoon Character(s) are registered trademarks of the Company.
This Prospectus also includes product and company names, trademarks and trade
names of companies other than the Company.
4
<PAGE>
REORGANIZATION OF THE COMPANY
The Company was incorporated in New Hampshire in September 1983 and
reincorporated in Delaware in February 1998 (the "Reincorporation"). Pursuant
to the Reincorporation the Company converted all of the issued and outstanding
shares of Series A Non-Voting Common Stock, $.01 par value per share (the "Non-
Voting Common Stock"), and Series B Voting Common Stock, $.01 par value per
share (the "Voting Common Stock"), of the New Hampshire Corporation into
11,798,793 shares of the Delaware corporation's Common Stock, $0.01 par value
per share (the "Common Stock"), on a one-for-one basis.
For all periods described in the Prospectus, the Company has elected to be
treated as an S Corporation under Subchapter S of the Code, and applicable
state tax laws. As a result of the S Corporation status of the Company, the
stockholders of the Company were taxed directly on the earnings of the Company.
Upon the consummation of the Offering, the status of the Company as an
S Corporation will terminate and the Company will be subject to federal and
state income taxes at applicable corporate tax rates (the "S Corporation
Termination," and together with the Reincorporation, the "Reorganization"). On
February 27, 1998, the Company declared a dividend of $2.80 per share (the
"S Corporation Dividend") to its then existing stockholders (the "S Corporation
Stockholders") representing substantially all previously taxed, but
undistributed, S Corporation earnings (aggregating approximately $33.0
million). After the consummation of the Offering, the Company will use a
portion of the net proceeds from the Offering to pay the S Corporation Dividend
to the S Corporation Stockholders. See "Use of Proceeds."
THE OFFERING
<TABLE>
<C> <S>
Common Stock offered by the
Company............................ 3,125,000 shares
Common Stock to be outstanding after
the Offering....................... 14,923,793 shares(1)
Use of Proceeds..................... Payment of the S Corporation Dividend;
repayment of debt; and working capital
and other general corporate purposes. See
"Use of Proceeds."
Nasdaq National Market symbol....... PCCC
</TABLE>
- --------------------
(1) Does not include (a) 1,124,163 shares of Common Stock issuable upon the
exercise of stock options outstanding as of January 31, 1998 with a
weighted average exercise price of $3.65 per share and (b) an additional
800,000 shares of Common Stock reserved for future issuance under the
Company's 1997 Stock Incentive Plan and 225,000 shares of Common Stock
reserved for future issuance under the Company's 1997 Employee Stock
Purchase Plan.
5
<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SELECTED OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net sales.............. $163,390 $196,659 $252,217 $333,322 $550,575
Gross profit........... 26,124 30,702 40,918 51,205 75,966
Selling, general and
administrative
expenses.............. 29,602 32,653 38,373 43,739 56,596
Additional
stockholder/officer
compensation(1)....... -- -- -- 1,259 12,130
Income (loss) from
operations............ (3,478) (1,951) 2,545 6,207 7,240
Net income (loss)...... (3,385) (2,341) 1,273 4,756 5,204
PRO FORMA DATA(2):
Net income....................................................... $10,890
=============
Basic net income per share(3).................................... $ 0.79
=============
Diluted net income per share(3).................................. $ 0.76
=============
SELECTED OPERATING DATA:
Active customers(4).... 258,000 295,000 353,000 424,000 510,000
Catalogs distributed... 10,000,000 16,900,000 16,800,000 18,600,000 33,800,000
Orders entered(5)...... 695,000 803,000 854,000 910,000 1,252,000
Average order size(5).. $264 $282 $346 $453 $524
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
--------------------------------------
PRO FORMA
ACTUAL PRO FORMA(6) AS ADJUSTED(6)(7)
------- ------------ -----------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital......................... $18,907 $(10,827) $35,832
Total assets............................ 105,442 109,942 109,942
Short-term debt......................... 29,568 29,568 15,909
Long-term debt (less current portion)... 3,250 3,250 --
Total stockholders' equity (deficit).... 24,120 (4,380) 45,529
</TABLE>
- --------------------
(1) Represents amounts accrued or distributed in excess of aggregate annual
base salaries approved by the Board of Directors and generally represents
Company-related federal income tax obligations payable by the stockholders.
(2) The pro forma data gives effect to (i) the elimination of
stockholder/officer compensation expense of $12,010 for the year ended
December 31, 1997, representing amounts in excess of aggregate annual base
salaries of $600 to be in effect as of the closing date of the Offering and
(ii) the Reorganization, including the Reincorporation, and the provision
for income taxes at an assumed rate of 39% based upon pro forma income of
the Company as if it had not elected to be treated as an S Corporation. The
increase in taxes amounted to $6,324 for the year ended December 31, 1997
to reflect taxation as a C Corporation.
(3) The denominator used to determine basic net income per share includes (i)
the weighted average common shares outstanding for the year and (ii) the
number of shares required to pay the S Corporation Dividend (assuming a
price per share of $16.00) (which dividend, if made at December 31, 1997,
would have approximated $33,000). The denominator used to determine diluted
net income per share includes the shares used in the calculation of basic
net income per share plus dilutive weighted average options outstanding in
1997. Based on an Offering price per share of $17.50 and an S Corporation
Dividend of $33,000, pro forma basic net income per share at December 31,
1997 would have been $0.80 and pro forma diluted net income per share at
December 31, 1997 would have been $0.77.
(4) All customers included in the Company's mailing list who have made a
purchase within the last twelve-month period.
(5)Does not reflect cancellations or returns.
(6) Reflects the declaration of the S Corporation Dividend estimated to be in
the amount of $33,000 at December 31, 1997 and establishment of an
additional net deferred income tax asset estimated to be approximately
$4,500 at December 31, 1997 resulting from the termination of the Company's
S Corporation status.
(7) Adjusted to give effect to the Offering and the application of the
estimated net proceeds therefrom to repay bank indebtedness and to pay the
S Corporation Dividend.
6
<PAGE>
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following factors should be carefully considered by prospective investors when
evaluating an investment in the Common Stock offered hereby.
NO ASSURANCE OF FUTURE GROWTH
Net sales have grown from $163.4 million for the year ended December 31,
1993 to $550.6 million for the year ended December 31, 1997. This growth has
placed increasing demands on the Company's management resources and
facilities. The Company's business strategy is to pursue additional growth and
expand its customer base, which is likely to result in additional demands on
the Company's resources. The Company's future success will depend in part on
the ability of the Company to manage any future growth effectively. There can
be no assurance that the Company will realize future growth in net sales or
will not experience decreases in net sales. See "Business--Growth Strategies."
RISKS RELATED TO TRANSITION OR EXPANSION OF FACILITIES
In November 1997, the Company entered into a fifteen-year lease for a new
103,000 square foot corporate headquarters facility in Merrimack, New
Hampshire with a company controlled by the Company's principal stockholders.
Significant renovation to this facility by the lessor is required prior to
occupancy by the Company. The Company expects to relocate its operations to
this new facility and vacate its current leased facility in Milford, New
Hampshire in the summer of 1998. The Company will likely incur certain moving
and other costs, not expected to exceed $500,000, relating to this relocation
which would be charged to operating results in the period incurred. Any
significant delay in the renovation of the new facility, or unanticipated
expense, capital cost or disruption of the Company's business or operations
caused by the relocation to the new facility, could have a material adverse
effect on the Company's financial position, results of operations and cash
flows. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Certain Transactions--Leases."
Additional and/or alternative facilities for distribution and inventory may
be required to support significant future growth in the Company's net sales,
if realized. There can be no assurance that suitable facilities will be
available, and in the absence of such facilities, future growth could be
impaired. See "Business--Distribution" and "Business--Facilities."
If the Company is unable to generate increased sales and gross profit
sufficient to absorb increased overhead and other costs associated with its
relocation and potential expansion, the Company would likely experience lower
profit margins which could have a material adverse effect on the Company's
financial position, results of operations and cash flows.
DEPENDENCE ON MANAGEMENT INFORMATION SYSTEMS
The Company's success is dependent on the accuracy, reliability and proper
use of its management information systems, including its telephone system, and
the information generated by its management information systems. The Company
does not currently have redundant systems for all functions performed by its
management information systems or a redundant or back-up telephone system. Any
interruption in these systems or in telephone service could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
The Company recognizes the need to continually upgrade its management
information systems to most effectively manage its operations and customer
data base. The Company plans to convert its order management and fulfillment
systems to new software by the end of the second quarter of 1998. There can be
no assurance that the transition to the new software will be accomplished
without interrupting the Company's business. This new software is designed to
be Year 2000 compliant, however, there can be no assurance that the software
contains all necessary data code changes. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business--
Management Information Systems."
7
<PAGE>
RAPID TECHNOLOGICAL CHANGE AND EXPOSURE TO INVENTORY OBSOLESCENCE
The market for personal computer products is characterized by rapid
technological change and the frequent introduction of new products and product
enhancements. The Company's success depends in part on its ability to identify
and market products that meet the needs of the marketplace. In order to
satisfy customer demand and to obtain favorable purchasing discounts, the
Company expects to carry increased inventory levels of certain products in the
future, which will subject it to increased risk of inventory obsolescence. In
the implementation of its business strategy, the Company intends, among other
things, to place larger than typical inventory stocking orders, increase its
participation in first-to-market purchase opportunities, and may in the future
participate in end-of-life-cycle purchase opportunities and market products on
a private-label basis, all of which will further increase the risk of
inventory obsolescence. Special purchase products are sometimes acquired
without return privileges and there can be no assurance that the Company will
be able to avoid losses related to obsolete inventory. In addition, some
manufacturers provide the Company with co-op advertising support in the form
of products, for which there may be no return privileges. Finally, certain
build-to-order programs currently being implemented by some computer systems
manufacturers will likely include reductions in the levels of price protection
and product returns made available by such manufacturers. See "Business--
Products and Merchandising."
AVAILABILITY AND ALLOCATION OF GOODS
The Company acquires products for resale from manufacturers as well as from
distributors. Purchases of products from the five vendors supplying the
greatest amount of goods to the Company constituted 48.0% and 46.5% of the
Company's total product purchases in the years ended December 31, 1996 and
1997, respectively. Among these five vendors, purchases from Ingram Micro,
Inc. ("Ingram Micro") represented 28.4% and 28.0% of the Company's total
product purchases in the years ended December 31, 1996 and 1997, respectively.
No other vendor supplied more than 10% of the Company's total product
purchases in the year ended December 31, 1997. The loss of Ingram Micro could
cause a short-term disruption in the availability of products and could have a
material adverse effect on the Company's financial position, results of
operations and cash flows.
Sales of products dependent on the Mac platform, including products
manufactured by Apple Computer, Inc. ("Apple"), represented 21.9% of the
Company's net sales in the year ended December 31, 1997. Published reports
indicate that Apple has been experiencing a decline in revenues and in its
share of the worldwide and domestic personal computer markets, as well as
operating losses. In November 1997, Apple announced that it will sell built-
to-order computers directly to customers over the Internet. The Company cannot
predict whether this action by Apple will affect the future supply of Macs to
the Company. The Company's sales of personal computers and other products
manufactured by Apple may be limited if the Company's reseller agreement with
Apple is curtailed or terminated or if product availability or financing is
otherwise restricted. Any decline in the availability of, or demand for, Macs
may have a material adverse effect on the Company's financial position,
results of operations and cash flows. See "Business--Products and
Merchandising."
Substantially all of the Company's contracts and arrangements with its
vendors that supply significant quantities of products are terminable by such
vendors or the Company without notice or upon short notice. Most of the
Company's product vendors provide the Company with trade credit, of which the
net amount outstanding at December 31, 1997 was $27.3 million. Termination,
interruption or contraction of the Company's relationships with its vendors,
including a reduction in the level of trade credit provided to the Company,
could have a material adverse effect on the Company's financial position,
results of operations and cash flows. See "Business--Purchasing and Vendor
Relations."
8
<PAGE>
Certain product manufacturers either do not permit the Company to sell the
full line of their products or limit the number of product units available to
direct marketers such as the Company. An element of the Company's business
strategy is to increase its participation in first-to-market purchase
opportunities. In the past, availability of certain desired products,
especially in the direct marketing channel, has been constrained. The
inability to source first-to-market purchase or similar opportunities, or the
reemergence of significant availability constraints, could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
RELIANCE ON VENDOR SUPPORT AND RELATIONSHIPS
Some product manufacturers and distributors provide the Company with
substantial incentives in the form of payment discounts, supplier
reimbursements, price protection and rebates. No assurance can be given that
the Company will continue to receive such incentives in the future or that it
will be able to collect outstanding amounts relating to any future incentives
in a timely manner or at all.
Most product manufacturers provide the Company with co-op advertising
support in exchange for product coverage in the Company's catalogs. This
support significantly defrays the expense of catalog production. The level of
co-op advertising support available to the Company from certain manufacturers
has declined. The level of support from some manufacturers may further decline
in the future. Such a decline could increase the Company's selling, general
and administrative expenses as a percentage of sales and have a material
adverse effect on the Company's financial position, results of operations and
cash flows. See "Business--Purchasing and Vendor Relations."
COMPETITIVE RISKS
The Company competes with many national and international direct marketers;
product manufacturers that sell directly to end users; specialty personal
computer retailers; personal computer and general merchandise superstores;
consumer electronic and office supply stores; and shopping services on
television, the Internet and commercial on-line networks. The Company competes
not only for customers, but also for co-op advertising support from personal
computer product manufacturers. Some of the Company's competitors are larger
and have substantially greater financial resources, superior operating
results, and larger catalog circulations and customer bases than the Company.
In addition, several direct marketers have recently been acquired by larger
competitors. This industry consolidation could result in short-term price-
cutting in certain markets. There can be no assurance that the Company will be
able to compete effectively with existing competitors or any new competitors
that may enter the market, or that the Company's financial position, results
of operations and cash flows will not be adversely affected by intensified
competition. See "Business--Competition."
PRICING RISKS
The personal computer industry has experienced intense price competition.
The Company believes that price competition may increase in the future and
that such competition could result in a reduction of the Company's profit
margins. Also, the Company has recently increased its sales of personal
computer hardware products that generally produce lower profit margins than
those associated with software products. Significant margin decreases could
have a material adverse effect on the Company's financial position, results of
operations and cash flows. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
9
<PAGE>
ECONOMIC RISKS
The market for personal computers and related products has grown rapidly in
recent years. Recent statements by industry observers have indicated that
there may be a slowdown in the growth rate of the personal computing industry.
If the growth of this market or the direct marketing channel were to cease or
decrease, the Company's financial position, results of operations and cash
flows would be materially adversely affected. Demand for many of the products
carried by the Company may be subject to economic cycles. The Company's
business and growth could be affected by the spending patterns of existing or
prospective customers, a recession or prolonged economic slowdown, the
cyclical nature of capital expenditures of businesses, continued competition
and pricing pressures and other trends in the general economy, any one of
which could have a material adverse effect on the Company's financial
position, results of operations and cash flows.
DEPENDENCE ON THIRD PARTY SHIPPERS
The Company ships approximately 90% of its products to customers by Airborne
Freight Corporation D/B/A "Airborne Express" ("Airborne Express"), with the
remainder being shipped by United Parcel Service of America, Inc. and other
overnight delivery and surface services. Strikes or other service
interruptions by such shippers could adversely affect the Company's ability to
market or deliver product on a timely basis and have a material adverse effect
on the Company's financial position, results of operations and cash flows. See
"Business--Distribution."
POTENTIAL INCREASES IN SHIPPING, PAPER AND POSTAGE COSTS
Shipping costs are a significant expense in the operation of the Company's
business. The Company has a long-term contract with Airborne Express for
shipment of its products under which the Company believes it has negotiated
favorable shipping rates. The Company generally invoices customers for
shipping and handling charges. There can be no assurance that the full cost,
including any future increases in the cost, of commercial delivery services
can be passed on to the Company's customers, which could have a material
adverse effect on the Company's financial position, results of operations and
cash flows. In addition, the current shipping rates under the Airborne Express
contract are scheduled for renegotiation in January 1999 and there can be no
assurance that such renegotiated rates will continue to be as favorable to the
Company, which could have a material adverse effect on the Company's financial
position, results of operations and cash flows. See "Business--Distribution"
and "Business--Marketing and Sales."
The Company also incurs substantial paper and postage costs related to its
marketing activities, including its catalog production and mailings. Any
increases in postal or paper costs could have a material adverse effect on the
Company's financial position, results of operations and cash flows.
HISTORICAL NET LOSSES; VARIABILITY OF QUARTERLY RESULTS
The Company has experienced significant fluctuations in its operating
results, and these fluctuations may continue in the future. The Company
incurred net losses in the years ended December 31, 1993 and 1994. The
Company's results of operations are significantly affected by many factors,
including seasonal and other fluctuations in demand for personal computer
products and in profit margins on products sold, catalog timing and
circulation, product availability, and timing of releases of new and upgraded
products. Many of these factors are outside the control of the Company. The
Company's operating results are heavily dependent upon its ability to predict
sales levels, monitor and control associated expenses, and carefully manage
all aspects of its operations, including product selection and pricing,
purchasing and payables practices, inventory management, and catalog funding,
production and circulation. If revenues do not meet expectations in any given
quarter, or if the Company experiences difficulty in monitoring or controlling
associated expenses, the Company's financial position, results of operations
and cash flows may be materially adversely affected. There can be no assurance
that the Company will be profitable on a quarterly or annual basis. It is
possible that in some future quarter the expectations of public market
analysts and investors will exceed the Company's operating results. In such
event, the price of the Common Stock would likely be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Selected Quarterly Financial Results."
10
<PAGE>
CHANGING METHODS OF DISTRIBUTION
The manner in which personal computers and related products are distributed
and sold is changing, and new methods of distribution and sale, such as on-
line shopping services, have emerged. Hardware and software manufacturers have
sold, and may intensify their efforts to sell, their products directly to end
users. From time to time, certain manufacturers have instituted programs for
the direct sales of large order quantities of hardware and software to certain
major corporate accounts. These types of programs may continue to be developed
and used by various manufacturers. Certain of the Company's vendors, including
Apple, Compaq Computer Corporation ("Compaq") and International Business
Machine Corporation ("IBM"), currently sell some of their products directly to
end users. In addition, manufacturers may attempt to increase the volume of
software products distributed electronically to end users. An increase in the
volume of products sold through or used by consumers of any of these
competitive programs or distributed electronically to end users could have a
material adverse effect on the Company's financial position, results of
operations and cash flows.
STATE SALES OR USE TAX COLLECTION UNCERTAINTIES
The Company presently collects sales tax only on sales of products to
residents of the State of Ohio. Sales to customers located within the State of
Ohio were less than 2% of the Company's net sales during the year ended
December 31, 1997. Various states have sought to impose on direct marketers
the burden of collecting state sales taxes on the sales of products shipped to
their residents. The United States Supreme Court recently affirmed its
position that it is unconstitutional for a state to impose sales or use tax
collection obligations on an out-of-state mail order company whose only
contacts with the state are limited to the distribution of catalogs and other
advertising materials through the mail and the subsequent delivery of
purchased goods by United States mail or by interstate common carrier.
However, legislation that would expand the ability of states to impose sales
tax collection obligations on direct marketers has been introduced in Congress
on many occasions. Due to its presence on various forms of electronic media
and other factors, the Company's contact with many states may exceed the
contact involved in the Supreme Court case. The Company cannot predict the
level of contact that is sufficient to permit a state to impose on the Company
a sales tax collection obligation. If the Supreme Court changes its position
or if legislation is passed to overturn the Supreme Court's recent decision,
the imposition of a sales or use tax collection obligation on the Company in
states to which it ships products would result in additional administrative
expenses to the Company, could result in price increases to the customer, and
could reduce demand for the Company's products or could otherwise have a
material adverse effect on the Company's financial position, results of
operations and cash flows.
DEPENDENCE ON KEY PERSONNEL
The Company's future performance will depend to a significant extent upon
the efforts and abilities of its senior executives. The competition for
qualified management personnel in the personal computer products industry is
very intense, and the loss of service of one or more of these persons could
have an adverse effect on the Company's business. The Company's success and
plans for future growth will also depend on its ability to hire, train and
retain skilled personnel in all areas of its business, including account
managers and technical support personnel. There can be no assurance that the
Company will be able to attract, train and retain sufficient qualified
personnel to achieve its business objectives. See "Management."
11
<PAGE>
CONTROL BY PRINCIPAL STOCKHOLDERS
After completion of the Offering, Patricia Gallup and David Hall, the
principal stockholders of the Company, will beneficially own or control, in
the aggregate, approximately 79% of the outstanding shares of Common Stock
(77% if the Underwriters' over-allotment option is exercised in full). Because
of their beneficial stock ownership, these stockholders will be able to
continue to elect the members of the Board of Directors and decide all matters
requiring stockholder approval at a meeting or by a written consent in lieu of
a meeting. Similarly, such stockholders will be in a position to (i) control
decisions to adopt, amend or repeal the Restated Certificate and the Company's
Bylaws, or take other actions requiring the vote or consent of the Company's
stockholders and (ii) prevent a takeover of the Company by one or more third
parties, or sell or otherwise transfer their stock to a third party, which
could deprive the Company's stockholders of a control premium that might
otherwise be realized by them in connection with an acquisition of the
Company. Such control may result in decisions that are not in the best
interest of the public stockholders of the Company. In connection with the
Offering, the principal stockholders placed all except 40,000 of the shares of
Common Stock of the Company that they beneficially own into a voting trust,
pursuant to which they are required to agree as to the manner of voting such
shares in order for the shares to be voted. Such provisions could discourage
bids for the shares of Common Stock at a premium as well as have a negative
impact on the market price of the shares of Common Stock. See "Certain
Transactions--Voting Trust." The Company has entered into various transactions
with the principal stockholders. See "Principal Stockholders" and "Certain
Transactions."
NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price of the Common Stock was determined by
negotiations between the Company and the Representatives of the Underwriters,
and may not be indicative of the market price for the Common Stock in the
future. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price. There can be no assurance that
an active trading market for the Common Stock will develop or be sustained
after the Offering. If a trading market develops, the market price of the
Common Stock may fluctuate widely as a result of various factors, such as
period-to-period fluctuations in the Company's operating results, sales of
Common Stock by principal stockholders, developments in the personal computer
industry or the methods of distribution of personal computer products,
competitive factors, regulatory developments, economic and other external
factors, general market conditions, and market conditions affecting stocks of
personal computer products manufacturers and resellers in particular. The
stock market in general, and the stocks of personal computer product resellers
in particular, have in the past experienced extreme volatility in trading
prices and volumes that has often been unrelated to operating performance.
Such market volatility may have a significant adverse effect on the market
price and marketability of the Common Stock. See "Underwriting."
12
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 14,923,793 shares of
Common Stock outstanding. The shares of Common Stock sold in the Offering will
be freely tradeable without restriction or further registration under the
Securities Act of 1933, as amended (the "Securities Act"), unless held by an
"affiliate" of the Company, as that term is defined under Rule 144 of the
Securities Act, which shares will be subject to the resale limitations of Rule
144. In connection with the Offering, the existing stockholders of the Company
agreed, and certain holders of stock options exercisable within 180 days after
the date of this Prospectus upon any exercise of such options will agree, not
to dispose of any shares for a period of 180 days from the date of this
Prospectus, and the Company has agreed not to dispose of any shares (other
than shares sold by the Company in the Offering or issuances by the Company of
certain employee stock options and shares covered thereby) for a period of 180
days from the date of this Prospectus, without the prior written consent of
Donaldson, Lufkin and Jenrette Securities Corporation. Upon expiration of such
180-day period, all shares of Common Stock held by the existing stockholders
(11,798,793 shares) will be eligible for sale subject to certain volume and
other limitations of Rule 144 under the Securities Act applicable to
"affiliates" of the Company and all shares of stock acquired upon exercise of
stock options may be sold pursuant to a registration statement to be filed by
the Company. In addition, the existing stockholders have certain demand and
piggyback registration rights with respect to all shares held by them. See
"Certain Transactions--Registration Rights Agreement." No prediction can be
made as to the effect, if any, that market sales of shares of Common Stock or
the availability of shares of Common Stock for sale will have on the market
price of the Common Stock from time to time. The sale of a substantial number
of shares held by the existing stockholders, whether pursuant to a subsequent
public offering or otherwise, or the perception that such sales could occur,
could adversely affect the market price of the Common Stock and could
materially impair the Company's future ability to raise capital through an
offering of equity securities. See "Shares Eligible for Future Sale" and
"Underwriting."
IMMEDIATE AND SUBSTANTIAL DILUTION
Investors in the Common Stock in the Offering will experience immediate and
substantial dilution in the net tangible book value of their shares of $14.45
per share. Additional dilution will occur upon exercise of outstanding stock
options. If the Company seeks additional capital in the future, the issuance
of shares or convertible debt to obtain such capital may lead to further
dilution. See "Dilution."
13
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,125,000 shares of
Common Stock offered by the Company hereby are estimated to be approximately
$49.9 million ($57.5 million if the Underwriters' over-allotment option is
exercised in full), after deducting underwriting discounts and commissions and
estimated offering expenses.
The Company plans to use approximately $16.9 million of the net proceeds
from the Offering to repay bank indebtedness (to the extent that such balances
are outstanding) comprising approximately $4.3 million of term debt and
approximately $12.6 million of short-term borrowings, each having a maturity
date of March 31, 2002, and bearing interest at the prime rate (8.5% per annum
at the date of this Prospectus), and approximately $33.0 million of the net
proceeds from the Offering to pay the S Corporation Dividend.
The Company intends to use any remaining net proceeds for general corporate
purposes, including working capital. Pending such uses, the net proceeds of
the Offering will be invested in interest-bearing or dividend-bearing,
investment grade securities.
DIVIDEND POLICY
The Company currently intends to retain its future earnings and has no plans
to pay cash dividends in the foreseeable future, other than the S Corporation
Dividend. The Company's bank credit agreement limits the payment of dividends
on the Common Stock. See Note 5 of the Company's Financial Statements included
elsewhere herein. The payment of future dividends will be determined by the
Board of Directors of the Company in light of conditions then existing,
including the Company's financial condition and requirements, future
prospects, restrictions in financing agreements, business conditions and other
factors deemed relevant by the Board of Directors. There can be no assurance
that the Company will determine to pay any cash dividends in the future.
14
<PAGE>
CAPITALIZATION
The following table sets forth the cash, debt and capitalization of the
Company as of December 31, 1997 (i) on an actual basis, (ii) on a pro forma
basis reflecting the S Corporation Dividend, the S Corporation Termination and
the Reincorporation and (iii) on a pro forma as adjusted basis reflecting the
sale of shares of Common Stock offered hereby and the application of the
estimated net proceeds from the Offering.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
-----------------------------------------------------
PRO PRO FORMA AS
ACTUAL FORMA(1) ADJUSTED(1)(2)
--------------- --------------- -------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Cash.................................................... $ 758 $ 758 $ 758
=============== =============== ===============
Short-term borrowings................................... $ 28,318 $ 28,318 $ 15,909
Dividends payable....................................... -- 33,000 --
Long-term debt (including current portion).............. 4,500 4,500 --
--------------- --------------- ---------------
Total debt.......................................... 32,818 65,818 15,909
--------------- --------------- ---------------
Stockholders' equity (deficiency):
Preferred stock, $.01 par value: 7,500,000 shares
authorized,
none issued and outstanding pro forma as adjusted(2).. -- --
Common stock, $.01 par value:
22,500,000 shares of Non-Voting Common Stock and
7,500,000 shares of Voting Common Stock authorized,
and 8,849,095 shares of Non-Voting Common Stock and
2,949,698 shares of Voting Common Stock issued and
outstanding, actual; 30,000,000 shares of Common
Stock authorized, and 11,798,793 shares of Common
Stock issued and outstanding, pro forma; 30,000,000
shares of Common Stock authorized, and 14,923,793
shares of Common Stock issued and outstanding, pro
forma as adjusted(2) ................................ 118 118 149
Additional paid in-capital (deficiency)............... 4,097 (4,498) 45,380
Retained earnings..................................... 19,905 -- --
--------------- --------------- ---------------
Total stockholders' equity (deficiency)............. 24,120 (4,380) 45,529
--------------- --------------- ---------------
Total capitalization.................................... $ 56,938 $ 61,438 $ 61,438
=============== =============== ===============
</TABLE>
- ---------------------
(1) Reflects the Reincorporation, and the declaration of the S Corporation
Dividend (which if made at December 31, 1997 would have approximated $33
million) and establishment of an additional net deferred income tax asset,
estimated to be approximately $4,500 at December 31, 1997, resulting from
the termination of the Company's S Corporation status.
(2) Gives effect to the Offering and the application of the estimated net
proceeds therefrom to repay bank indebtedness and to pay the S Corporation
Dividend. Excludes (a) 1,094,010 shares of Common Stock issuable upon the
exercise of stock options outstanding as of December 31, 1997 with a
weighted average exercise price of $3.31 per share and (b) an additional
30,153 shares of Common Stock reserved for future issuance under the
Company's 1993 Incentive and Non-Statutory Stock Option Plan, 800,000
shares of Common Stock reserved for future issuance under the Company's
1997 Stock Incentive Plan and 225,000 shares of Common Stock reserved for
future issuance under the Company's 1997 Employee Stock Purchase Plan.
15
<PAGE>
DILUTION
At December 31, 1997, after giving effect to (i) the Reorganization and (ii)
payments of the S Corporation Dividend the Company had a pro forma net
tangible book value of approximately $(4,380) or $(0.37) per share of Common
Stock. "Net tangible book value" represents the amount of total assets less
total liabilities divided by the number of shares of Common Stock outstanding.
Without taking into account any other changes in the net tangible book value
after December 31, 1997, other than to give effect to the sale of the
3,125,000 shares of Common Stock offered by the Company hereby after deducting
underwriting discounts and estimated offering expenses payable by the Company,
the pro forma net tangible book value of the Company as of December 31, 1997
would have been approximately $45,529 or $3.05 per share. This represents an
immediate increase in net tangible book value of $3.42 per share to the
existing stockholders and an immediate dilution of $14.45 per share to new
investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price.............................. $17.50
Net tangible book value as of December 31, 1997.......... $2.04
Net decrease attributable to S Corporation Dividend and S
Corporation Termination................................. (2.41)
-----
Pro forma net tangible book value before the Offering.... (0.37)
Increase in net tangible book value attributable to new
investors............................................... 3.42
-----
Pro forma net tangible book value after the Offering....... $ 3.05
------
Dilution to new investors.................................. $14.45
======
</TABLE>
The following table summarizes on a pro forma basis, as of December 31,
1997, the differences between existing stockholders and new investors in the
Offering with respect to the number of shares of Common Stock purchased from
the Company, the total consideration paid and the average price per share
paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 11,798,793 79.1% $ 8,000 0.0% $ 0.00
New investors.............. 3,125,000 20.9% 54,687,500 100.0% $17.50
---------- ----- ----------- -----
Total.................... 14,923,793 100.0% $54,695,500 100.0%
========== ===== =========== =====
</TABLE>
As of December 31, 1997, options to purchase 1,094,010 shares of Common
Stock were outstanding with a weighted average exercise price of $3.31 per
share and are not reflected in the above tables. See "Capitalization,"
"Management--Stock Plans" and Notes 7 and 12 of the Financial Statements.
16
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following selected financial and operating data should be read in
conjunction with the Company's Financial Statements and the Notes thereto, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere herein. The selected data presented below
under the captions "Statement of Operations Data" and "Balance Sheet Data" for
each of the years in the five-year period ended December 31, 1997 are derived
from the audited financial statements of the Company. The Company's financial
statements as of December 31, 1996 and 1997 and for each of the years in the
three-year period ended December 31, 1997 and the independent auditors' report
thereon, are included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SELECTED OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Net sales.............. $163,390 $196,659 $252,217 $333,322 $550,575
Cost of sales.......... 137,266 165,957 211,299 282,117 474,609
------------- ------------- ------------- ------------- -------------
Gross profit........... 26,124 30,702 40,918 51,205 75,966
Selling, general and
administrative
expenses.............. 29,602 32,653 38,373 43,739 56,596
Additional
stockholder/officer
compensation(1)....... -- -- -- 1,259 12,130
------------- ------------- ------------- ------------- -------------
Income (loss) from
operations............ (3,478) (1,951) 2,545 6,207 7,240
Interest expense....... (274) (594) (1,296) (1,269) (1,355)
Other, net............. 367 80 62 70 (42)
Income taxes(2)........ -- 124 (38) (252) (639)
------------- ------------- ------------- ------------- -------------
Net income (loss)...... $(3,385) $(2,341) $1,273 $4,756 $5,204
============= ============= ============= ============= =============
PRO FORMA DATA(3):
Net income ...................................................... $10,890
=============
Basic net income per share(4).................................... $ 0.79
=============
Diluted net income per share(4).................................. $ 0.76
=============
SELECTED OPERATING DATA:
Active customers(5).... 258,000 295,000 353,000 424,000 510,000
Catalogs distributed... 10,000,000 16,900,000 16,800,000 18,600,000 33,800,000
Orders entered(6)...... 695,000 803,000 854,000 910,000 1,252,000
Average order size(6).. $264 $282 $346 $453 $524
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........ $7,383 $2,770 $10,994 $14,622 $18,907
Total assets........... 38,821 53,830 49,661 77,358 105,442
Short-term debt........ 6,905 6,106 4,933 13,057 29,568
Long-term debt (less
current maturities)... -- -- 5,000 4,250 3,250
Total stockholders'
equity................ 13,702 11,687 13,057 18,043 24,120
</TABLE>
(footnotes on next page)
17
<PAGE>
(footnotes from previous page)
- ---------------------
(1) Represents amounts accrued or distributed in excess of aggregate annual
base salaries approved by the Board of Directors and generally represents
Company-related federal income tax obligations payable by the
stockholders.
(2) For all periods presented, the Company has been an S Corporation and
accordingly has not been subject to federal income taxes.
(3) The pro forma adjustments give effect to (i) the elimination of
stockholder/officer compensation expense of $12,010 for the year ended
December 31, 1997, representing amounts in excess of aggregate annual base
salaries of $600 to be in effect as of the closing date of the Offering
and (ii) the Reorganization, including the Reincorporation and the
provision for income taxes at an assumed rate of 39% based upon pro forma
income of the Company as if it had not elected to be treated as an S
Corporation. The increase in taxes amounted to $6,324 for the year ended
December 31, 1997 to reflect taxation as a C Corporation.
(4) The denominator used to determine basic net income per share includes (i)
the weighted average common shares outstanding for the year and (ii) the
number of shares required to pay the S Corporation Dividend (assuming a
price per share of $16.00) (which dividend, if made at December 31, 1997,
would have approximated $33,000). The denominator used to determine
diluted net income per share includes the shares used in the calculation
of basic net income per share plus dilutive weighted average options
outstanding in 1997. Based on an Offering price per share of $17.50 and an
S Corporation Dividend of $33,000, pro forma basic net income per share at
December 31, 1997 would have been $0.80 and pro forma diluted net income
per share at December 31, 1997 would have been $0.77.
(5) All customers included in the Company's mailing list who have made a
purchase within the last twelve-month period.
(6) Does not reflect cancellations or returns.
18
<PAGE>
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
financial statements and unaudited pro forma December 31, 1997 balance sheet
included elsewhere herein.
GENERAL
The Company was founded in 1982 as a mail-order business offering a broad
range of software and accessories for IBM and IBM-compatible personal
computers. The founders' goal was to provide consumers with superior service
and high quality branded products at competitive prices. The Company initially
sought customers through advertising in magazines and the use of inbound toll
free telemarketing. Currently, the Company seeks to generate sales through (i)
outbound telemarketing by account managers focused on the business, education
and government markets and (ii) inbound calls from customers responding to the
Company's catalogs and other advertising. The Company also advertises in
selected computer industry publications and in 1996 commenced selling products
through its Internet Web site.
The Company offers both PC compatible products and Mac compatible products.
Reliance on Mac product sales has decreased over the last two years, from
26.7% of net sales in 1995 to 21.9% of net sales for the year ended December
31, 1997. In November 1997, Apple announced that it will sell built-to-order
computers directly to customers over the Internet. While Apple also indicated
that it is not abandoning traditional retail and direct marketing outlets, the
Company cannot predict whether direct sales by Apple will affect the future
supply of Macs to the Company. Although net sales attributable to Mac products
increased in the year ended December 31, 1997, as compared to the comparable
period in 1996, the Company believes that such sales will continue to decrease
as a percentage of net sales and may decline in dollar volume in 1998 and
future years.
All of the Company's product categories experienced strong growth in the
year ended December 31, 1997 with sales of computer systems representing the
fastest growing category. Sales of computer systems result in a relatively
high dollar sales order, as reflected in the increase in the Company's average
order size from $346 in the year ended December 31, 1995 to $524 for the year
ended December 31, 1997. Computer system sales generally provide the largest
gross profit dollar contribution per order of all of the Company's products,
although they generally yield the lowest gross margin percentage. Partially as
a result of higher system sales, the Company's gross margin has declined over
the last two years while the operating income margin has increased due to the
leveraging of selling, general and administrative expenses over a larger sales
base.
The Company's profit margins are also influenced by, among other things,
industry pricing and the relative mix of inbound versus outbound sales.
Generally, pricing in the computer and related products market is very
aggressive and the Company intends to maintain prices at competitive levels.
Since outbound sales are typically to corporate accounts that purchase at
volume discounts, the gross margin on such sales is generally lower than
inbound sales, although the gross profit dollar contribution per order is
generally higher as average order sizes to corporate accounts are usually
larger. The Company believes that outbound sales will continue to represent a
larger portion of its business mix in future periods.
The direct marketing of personal computers and related products is highly
competitive. In addition to other direct marketers and manufacturers who sell
direct, such as Dell Computer Corporation and Gateway 2000, Inc.,
manufacturers of PCs sold by the Company, such as Compaq and IBM, have also
announced varying plans to sell PCs directly to end users. Separately, both
Compaq and IBM have announced plans to increase their reliance on reseller
arrangements with direct marketers such as the Company as part of their own
marketing programs designed to compete more effectively with Dell and Gateway.
The Company currently believes that direct sales by Compaq and IBM will not
have a significant adverse effect upon the Company's net sales.
19
<PAGE>
Most product manufacturers provide the Company with co-op advertising
support in exchange for product coverage in the Company's catalogs. Although
the level of co-op advertising support available to the Company from certain
manufacturers has declined, and may decline further in the future, the overall
level of co-op advertising revenues has continued to increase consistent with
the Company's increased levels of spending for catalog and other advertising
programs. The Company believes that the overall levels of co-op advertising
revenues available over the next twelve months will be consistent with the
Company's planned advertising programs.
In connection with the Offering, the Company expects to report the following
non-recurring, non-cash items in the quarter ending March 31, 1998: (i) an
$870,000 charge to income from operations resulting from the acceleration of
the amortization of certain stock option compensation expense from seven years
to four years and (ii) a $4.5 million tax benefit (estimated at December 31,
1997) related to the establishment of additional deferred tax assets for
future tax deductions resulting from the S Corporation Termination.
In connection with the planned relocation of its headquarters facility in
the summer of 1998, the Company will likely incur certain one-time moving and
other costs, not expected to exceed $500,000, which would be charged to
operating results in the periods incurred.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated information derived
from the Company's statements of operations expressed as a percentage of net
sales.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
<S> <C> <C> <C>
------- ------- -------
Net sales (in millions).............................. $ 252.2 $ 333.3 $ 550.6
======= ======= =======
Net sales............................................ 100.0% 100.0% 100.0%
Gross profit......................................... 16.2 15.4 13.8
Selling, general and administrative expenses......... 15.2 13.1 10.3
Additional stockholder/officer compensation.......... 0.0 0.4 2.2
Income from operations............................... 1.0 1.9 1.3
Interest expense..................................... (0.5) (0.4) (0.2)
Income taxes......................................... (0.0) (0.1) (0.1)
Net income........................................... 0.5 1.4 0.9
Pro forma net income................................. 2.0
</TABLE>
20
<PAGE>
The following table sets forth for the periods indicated the Company's
percentage of net sales (in dollars) of computer systems/memory, peripherals,
software and networking and communications products.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
PRODUCT CATEGORIES 1995 1996 1997
------------------ ------- ------- -------
<S> <C> <C> <C>
Computer Systems/Memory.............................. 25.4% 34.8% 42.2%
Peripherals.......................................... 39.4 38.0 34.3
Software............................................. 23.4 17.6 15.8
Networking and Communications........................ 11.8 9.6 7.7
------- ------- -------
Total.............................................. 100.0% 100.0% 100.0%
======= ======= =======
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net Sales increased $217.3 million, or 65.2%, to $550.6 million in 1997 from
$333.3 million in 1996. Growth in net sales, which included a 15.7% increase
in average order size, was primarily attributable to: (i) improvements in
merchandising and product mix, especially a greater emphasis on the stocking
and sale of computer systems; (ii) continued expansion and increased
productivity of the Company's outbound telemarketing group; (iii) an increase
in the number of catalog mailings; and (iv) improved inbound sales conversion
ratios. System/memory sales increased to 42.2% of net sales in 1997 from 34.8%
in 1996. Outbound sales increased $130.5 million, or 103.1%, to $257.2 million
in 1997 from $126.7 million in 1996. The number of catalogs mailed increased
by 81.7%, from 18.6 million catalogs in 1996 to 33.8 million catalogs in 1997.
Gross Profit increased $24.8 million, or 48.4%, to $76.0 million in 1997
from $51.2 million in 1996. The increase in gross profit dollars was primarily
attributable to the increase in net sales described above. Gross profit margin
decreased from 15.4% in 1996 to 13.8% in 1997 due primarily to a higher rate
of growth in sales of lower margin computer systems, increased price
competition, decreases in average unit selling prices and an increase in the
rate of charges to cost of sales for slow-moving and obsolete inventory.
However, the Company generated higher gross profit dollars per order, enabling
it to leverage its operating expenses, as described below.
Selling, general and administrative expenses increased $12.8 million, or
29.4%, to $56.6 million in 1997 from $43.7 million in 1996, but decreased as a
percentage of sales to 10.3% in 1997 from 13.1% in 1996. The increase in
expenses was primarily attributable to increases in volume-sensitive costs
such as sales personnel and credit card fees. The decrease as a percentage of
net sales was primarily attributable to improved expense control and the
leveraging of selling, general and administrative expenses over a larger sales
base.
Additional stockholder/officer compensation paid to the Company's two
stockholders who also serve as officers and directors represents amounts
accrued or distributed in excess of aggregate annual base salaries ($480,000
base salaries for each of 1997 and 1996) approved by the Board of Directors of
the Company and generally represent Company-related federal income tax
obligations payable by the stockholders. Effective upon the closing of the
Offering, these stockholder/officers will be paid annual base salaries
aggregating $600,000. Selling, general and administrative expenses on a pro
forma basis were $56.7 million (or 10.3% of net sales) for 1997, as adjusted
to give effect to $600,000 of aggregate bases salaries payable to the
Company's two stockholder/officers.
Additional stockholder/officer compensation increased $10.8 million, or
863.5%, to $12.1 million in 1997 from $1.3 million in 1996. This increase is
attributable to increases in net income.
21
<PAGE>
Income from operations increased by $1.0 million, or 16.6%, to $7.2 million
in 1997 from $6.2 million in 1996. Income from operations as a percentage of
net sales decreased from 1.9% to 1.3% for the reasons discussed above. Income
from operations, excluding additional stockholder/officer compensation, for
the years ended December 31, 1997 and 1996 was $19.4 million and $7.5 million,
respectively, an increase of $11.9 million, or 159.4%. Income from operations
as a percentage of net sales, excluding additional stockholder/officer
compensation, increased from 2.2% to 3.5% for the reasons discussed above.
Interest expense in 1997 increased $86,000, or 6.8%, to $1.4 million in 1997
from $1.3 million in 1996, primarily due to higher average outstanding
borrowings under the Company's line of credit.
Net income increased $448,000, or 9.4%, to $5.2 million in 1997 from $4.8
million in 1996, principally as a result of the increase in income from
operations.
Pro forma net income is determined by (i) eliminating stockholder/officer
compensation in excess of the aggregate base salaries ($600,000) described
above under "selling, general and administrative expenses" and (ii) adding a
provision for federal income taxes that would have been payable by the Company
if taxed under Subchapter C of the Code. Net income on a pro forma basis as
described above would have been $10.9 million for 1997. The difference in pro
forma net income compared to historical net income represents the elimination
of $12.0 million in stockholder/officer compensation offset by a $6.3 million
higher provision for federal income taxes.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net sales increased $81.1 million, or 32.2%, to $333.3 million in 1996 from
$252.2 million in 1995. Growth in net sales, which included a 30.9% increase
in average order size, was primarily attributable to improvements in
merchandising and product mix, especially growth in computer systems, and a
significant expansion of the Company's outbound telemarketing group from 40 to
100 account managers, together with an increase in outbound sales per account
manager for those account managers with more than 12 months of service.
Outbound sales increased $72.2 million, or 132.6%, to $126.7 million in 1996
from $54.5 million in 1995.
Gross profit increased $10.3 million, or 25.1%, to $51.2 million in 1996
from $40.9 million in 1995. Gross profit margin decreased from 16.2% in 1995
to 15.4% in 1996 due to more competitive pricing of the Company's products,
significant growth in sales of computer systems, which carry lower gross
margins, and an increase in the rate of charges to cost of sales for slow-
moving and obsolete inventory. These decreases were partially offset by the
Company's ability, as a result of its increased volume and financial position,
to take advantage of vendor discounts, rebates and bulk purchasing
opportunities.
Selling, general and administrative expenses increased $5.4 million, or
14.0%, to $43.7 million in 1996 from $38.4 million in 1995, but decreased as a
percentage of sales to 13.1% in 1996 from 15.2% in 1995. The increase in
expense was attributable to an increase in volume-sensitive costs such as
sales personnel and credit card fees. The decrease as a percentage of net
sales was primarily attributable to management attention to expense control
and the leveraging of selling, general and administrative expenses over a
larger sales base.
Additional stockholder/officer compensation increased to $1.3 million in
1996 from $0 in 1995. This increase is primarily attributable to distributions
to stockholders representing Company-related federal income tax obligations
payable by stockholders.
22
<PAGE>
Income from operations increased by $3.7 million, or 143.9%, to $6.2 million
in 1996 from $2.5 million in 1995. Income from operations as a percentage of
net sales increased from 1.0% to 1.9% for the reasons discussed above. Income
from operations, excluding additional stockholder/officer compensation, for
the years ended December 31, 1996 and 1995 was $7.5 million and $2.5 million,
respectively, an increase of $5.0 million, or 193.4%.
Interest expense remained unchanged at $1.3 million in 1996 and 1995. Lower
interest rates and average short-term borrowings in 1996 were offset by the
increased interest expense associated with the $5.0 million term loan obtained
in late 1995.
Net income increased $3.5 million, or 273.6%, to $4.8 million in 1996 from
$1.3 million in 1995, principally as a result of the increase in income from
operations.
SELECTED QUARTERLY FINANCIAL RESULTS
The following table sets forth certain unaudited quarterly data of the
Company for each of the quarters since January 1, 1995. This information has
been prepared on the same basis as the audited Financial Statements and all
necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts stated below to present fairly the selected
quarterly information when read in conjunction with the audited Financial
Statements and the Notes thereto included elsewhere in this Prospectus. The
quarterly operating results are not necessarily indicative of future results
of operations. See "Risk Factors--Historical Net Losses; Variability of
Quarterly Results."
<TABLE>
<CAPTION>
QUARTERS ENDED
--------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1995 1995 1995 1995
--------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............................. $ 62,856 $ 60,434 $ 59,802 $ 69,125
Gross profit.......................... 10,247 9,736 9,737 11,198
Selling, general and administrative
expenses............................. 10,359 9,606 9,456 8,952
Additional stockholder/officer
compensation......................... -- -- -- --
Income (loss) from operations......... (112) 130 281 2,246
<CAPTION>
QUARTERS ENDED
--------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996
--------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............................. $ 70,108 $ 72,014 $ 82,952 $108,248
Gross profit.......................... 10,995 11,381 13,054 15,775
Selling, general and administrative
expenses............................. 9,887 10,040 11,078 12,734
Additional stockholder/officer
compensation......................... 350 503 554 (148)
Income from operations................ 758 838 1,422 3,189
<CAPTION>
QUARTERS ENDED
--------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997
--------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............................. $122,823 $121,500 $139,137 $167,115
Gross profit.......................... 17,379 16,777 19,296 22,514
Selling, general and administrative
expenses............................. 13,637 12,791 14,537 15,631
Additional stockholder/officer
compensation......................... 2,450 2,980 3,200 3,500
Income from operations ............... 1,292 1,006 1,559 3,383
</TABLE>
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations and capital
expenditures through cash flow from operations and bank borrowings. The
Company believes that funds generated from operations, together with the net
proceeds from the Offering and available credit under its bank line of credit,
will be sufficient to finance its working capital and capital expenditure
requirements at least through 1998. The Company plans to use the net proceeds
of the Offering to repay bank indebtedness, pay the S Corporation Dividend and
for working capital. See "Use of Proceeds." The Company's ability to continue
funding its planned growth is dependent upon its ability to generate
sufficient cash flow from operations or to obtain additional funds through
equity or debt financing, or from other sources of financing, as may be
required.
At December 31, 1997, the Company had cash of $758,000 and working capital
of $18.9 million. At December 31, 1996, the Company had working capital of
$14.6 million.
Net cash used in operating activities was $2.8 million, $4.5 million and
$10.4 million for the years ended December 31, 1995, 1996, and 1997,
respectively. The primary factors historically affecting cash flows from
operations are the Company's net income and changes in the levels of accounts
receivable, inventories and accounts payable. Historically, inventories and
accounts payable have increased as a result of the sales growth of the
Company. Accounts receivable have increased primarily due to an increase in
open account purchases by commercial customers resulting from the Company's
continued efforts to increase its sales to such customers offset in part by a
higher rate of increase in accounts receivable allowances for sales returns
and doubtful accounts related to the growth in sales and the
disproportionately higher level and complexity of settlement claims with
vendors.
Capital expenditures were $3.4 million and $4.5 million in the years ended
December 31, 1996 and 1997 respectively. The Company expects capital
expenditures, primarily for the purchase of computer hardware and software and
other fixed assets, to be approximately $4.0 million for the year ending
December 31, 1998.
As of December 31, 1997, the Company had a credit agreement with a bank
providing for short-term borrowings equal to the lesser of $45 million or an
amount determined by a formula based on accounts receivable and inventory
balances, and a term loan for $5 million, due in quarterly installments of
$250,000 through March 31, 2002. Short-term borrowings, which totalled $28.3
million at December 31, 1997, are collateralized by the Company's accounts
receivable and inventories (other than inventories pledged to secure trade
credit arrangements) and bear interest at the bank's prime rate (8.5% at
December 31, 1997) or LIBOR plus 2.0% at the Company's option. The term loan,
which totalled $4.5 million at December 31, 1997, is collateralized by all
other assets of the Company and bears interest at the prime rate (8.5% at
December 31, 1997). The credit agreement includes various customary financial
and operating covenants, including restrictions on the payment of dividends,
except for dividends to stockholders in respect of income taxes, none of which
the Company believes significantly restricts the Company's operations. At
December 31, 1997, the Company had $38.2 million in outstanding accounts
payable. Such accounts are generally paid within 30 days of incurrence and
will be financed by cash flows from operations or short-term borrowings under
the line of credit.
INFLATION
The Company has historically offset any inflation in operating costs by a
combination of increased productivity and price increases, where appropriate.
The Company does not expect inflation to have a significant impact on its
business in the future.
24
<PAGE>
YEAR 2000 COMPLIANT INFORMATION SYSTEMS
The Company uses software and related technologies throughout its business
that will be affected by the Year 2000 problem, which is common to most
corporations, and concerns the inability of information systems, primarily
computer software programs, to properly recognize and process date sensitive
information as the year 2000 approaches. The Company's order management and
fulfillment software system is not currently Year 2000 compliant. However, the
Company plans to replace this system in 1998 with new software that is better
suited to the Company's expected scale of operations and is designed to be
Year 2000 compliant. See "Business--Management Information Systems." The
Company currently believes it will be able to modify or replace any other
affected systems in time to minimize any detrimental effects on operations.
While it is not possible, at present, to give an accurate estimate of the cost
of this work, the Company expects that such costs will not be material to the
Company's results of operations. System maintenance or software modification
costs will be expensed as incurred, while the costs of new software (such as
the new order management and fulfillment software) will be capitalized and
amortized over the software's expected useful life.
RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
Recent pronouncements of the Financial Accounting Standards Board ("FASB")
which are not required to be adopted at December 31, 1997, include the
following Statements of Financial Accounting Standards ("SFAS"):
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income (all changes in equity during a
period except those resulting from investments by and distributions to owners)
and its components in the financial statements. This new standard, which will
be effective for the Company for the year ending December 31, 1998, is not
currently anticipated to have a significant impact on the Company's financial
statement disclosures based on the current financial structure and operations
of the Company.
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," which will be effective for the Company for the year ending
December 31, 1998, establishes standards for reporting information about
operating segments in the annual financial statements, selected information
about operating segments in interim financial reports and disclosures about
products and services, geographic areas and major customers. This new standard
may require the Company to report financial information on the basis that is
used internally for evaluating segment performance and deciding how to
allocate resources to segments, which may result in more detailed information
in the notes to the Company's financial statements than is currently required
and provided. The Company has not yet determined the effects, if any, of
implementing SFAS No. 131 on its reporting of financial information.
25
<PAGE>
BUSINESS
GENERAL
PC Connection is a direct marketer of brand-name personal computers and
related peripherals, software, accessories and networking products. The
Company's primary target customers are SMORGS comprised of 20 to 1,000
employees. PC Connection sells its products through a combination of targeted
direct mail catalogs, outbound telemarketing, its Internet Web site and
advertisements on the Internet and in selected computer magazines. The Company
offers a broad selection of approximately 15,000 products targeted for
business use at competitive prices, including products from Compaq, Hewlett-
Packard Company, Toshiba Corporation, IBM, Microsoft Corporation
("Microsoft"), Sony Corporation, Hitachi Ltd. and Apple. Net sales of
Microsoft Windows or MS-DOS based personal computers ("PCs") and compatible
products were approximately 78.1% of net sales in 1997. The Company's most
frequently ordered products are carried in inventory and are typically shipped
to customers the same day that the order is received.
The Company has experienced rapid growth in sales, profitability, number of
orders and average order size as a result of: (i) a substantial increase in
the number and assortment of products carried by the Company; (ii) increases
in outbound telemarketing personnel and improvements in productivity; (iii)
increases in catalog circulation; and (iv) improvements in inbound
telemarketing productivity. The Company recorded net sales of $550.6 million
and income from operations of $7.2 million in 1997, representing increases of
65.2% and 16.6%, respectively, over 1996. Excluding additional
stockholder/officer compensation of $12.1 million (which represented Company-
related federal income tax obligations payable by stockholders under
Subchapter S of the Code), income from operations was $19.4 million in 1997,
representing an increase of 159.4% over the comparable amount in 1996. The
Company recorded net sales of $333.3 million and income from operations of
$6.2 million in the year ended December 31, 1996, representing increases of
32.2% and 143.9%, respectively, over the year ended December 31, 1995.
Excluding additional stockholder/officer compensation of $1.3 million (which
represented Company-related federal income tax obligations payable by
stockholders under Subchapter S of the Code), income from operations was $7.5
million in 1996, representing an increase of 193.4% over the comparable amount
in 1995.
Since its founding in 1982, the Company has focused on serving customer
needs by providing innovative, reliable and timely customer service and
technical support, and offering an extensive assortment of branded products,
through knowledgeable and well-trained sales and support teams. The
effectiveness of this strategy is reflected in the recognition accorded the
Company, including the Company's receipt of the PC World "World Class Award
for Best Mail-Order Company" in 1997, as voted by its readers, for the seventh
time in the past eight years, and receipt of the highest ranking of only two
direct resellers included in the first-ever ranking of the "100 Most
Influential Companies in the Computer Industry" by PC Magazine in July 1997.
The Company believes that its consistent customer focus has resulted in the
development of strong brand name recognition and a broad and loyal customer
base. At December 31, 1997, the Company's mailing list consisted of
approximately 2,000,000 customers and potential customers, of which
approximately 500,000 had purchased products from the Company within the last
twelve months. Approximately 65% of the Company's net sales in the year ended
December 31, 1997 were made to customers who had previously purchased products
from the Company. The Company believes it has also developed strong
relationships with vendors, resulting in favorable product allocations and
marketing assistance.
Commencing in late 1995, the Company significantly increased its business-
to-business marketing efforts targeting SMORGS, a rapidly growing sector of
the personal computer market that the Company believes is particularly
receptive to purchases from direct marketers. To serve this growing part of
its business more effectively, the Company has increased the number of its
outbound telemarketing account managers from 48 at December 31, 1995 to 155 at
December 31, 1997, including 90 new account managers with less than 12 months
of outbound telemarketing experience with the Company. Historically, outbound
account managers become significantly more productive in their second year
with the Company. In addition, in late 1995 the Company
26
<PAGE>
initiated programs to increase training of inbound telemarketing personnel and
to provide incentive compensation based upon sales productivity.
The Company's two major catalogs are PC Connection(R), focused on PCs and
compatible products, and MacConnection(R), focused on Macs and compatible
products. With colorful illustrations, concise product descriptions, relevant
technical information, along with customer service benefits and toll-free
telephone numbers for ordering, the Company's catalogs are recognized as a
leading source for personal computer hardware, software and other related
products. The Company distributed approximately 34 million catalogs during the
year ended December 31, 1997.
The Company also markets its products and services through its Internet Web
site, www.pcconnection.com, which provides customers and prospective customers
with Company and product information and enables customers to place electronic
orders for all of the Company's products. The Company believes that as the
Internet becomes a more important commercial medium, it will be well
positioned to capitalize on growth through this emerging channel.
INDUSTRY BACKGROUND
According to industry data published by Merrin in May 1997, United States
sales of personal computers and related products were $77.8 billion in 1996
and are expected to be $138.2 billion in 2000, representing a compound annual
growth rate of 15.4%. The Company believes that the direct marketing channel
will be among the fastest growing distribution channels for the domestic
personal computer and related products industry. As a leading participant in
the direct marketing channel, the Company believes it is well positioned to
capitalize on the expected growth in the industry.
The Company believes that the sales of personal computers and related
products have increased principally as a result of (i) technological advances
leading to significant improvements in performance, functionality and ease of
use; (ii) lower prices and improved price/performance made possible by
technological advances and driven by intense competition among manufacturers,
retailers and resellers; (iii) increased dependence upon PCs by businesses,
educational institutions and governments; and (iv) the emergence of industry
standards and component commonality. The Company believes that the higher
projected growth for the direct marketing channel is primarily based on (i)
increased user familiarity with PCs, coupled with the emergence of industry
standards and component commonality, and the resultant increase in customer
comfort with purchasing products without the need to "touch and feel" them,
and (ii) broader product offerings, lower prices and greater purchasing
convenience that direct marketers generally provide over traditional retail
stores and local dealers.
Users of personal computers range from large corporate entities focused on
business applications to individual consumers focused primarily on personal
productivity, education and entertainment applications. Historically, large
corporate resellers have served the needs of FORTUNE 1000 companies and
retailers have competed to serve the consumer market. SMORGS, the Company's
core target customers, are being served by a wide range of suppliers,
including direct marketers, large retailers, and small, independent value
added resellers ("VARs") and local dealerships. The Company believes that the
direct field sales model used by large resellers is not an efficient method of
reaching SMORGS, and that VARs, local dealerships and retailers are unable to
match the high level of customer service, extensive array of products, low
prices and efficiencies afforded to SMORGS by direct marketers. Intense
competition for market share has led manufacturers of PCs and related products
to use all available channels to distribute products, including direct
marketers. Although certain manufacturers that have traditionally used
resellers to distribute their products have established or attempted to
establish their own direct marketing operations, to the Company's knowledge
only one has replaced its traditional indirect selling channels as the
principal means of distribution. Accordingly, the Company believes these
manufacturers will continue to provide favorable product allocations and
marketing support to third-party direct marketers.
The Company believes new entrants to the direct marketing channel must
overcome a number of significant barriers to entry, including the time and
resources required to build a customer base of meaningful size, quality
27
<PAGE>
and responsiveness for cost-effective circulation; costs of developing the
information and operating infrastructure required by direct marketers; the
advantages enjoyed by larger and more established competitors in terms of
purchasing and operating efficiencies; the difficulty of building
relationships with manufacturers to achieve favorable product allocations,
attractive pricing terms and cooperative advertising funds; and the difficulty
of identifying and recruiting management personnel with significant direct
marketing experience in the industry.
BUSINESS STRATEGIES
The Company's objective is to become the leading supplier of personal
computers and related products and services to its customers. The key elements
of the Company's business strategies include:
. AWARD-WINNING CUSTOMER SERVICE BEFORE, DURING AND AFTER THE SALE. The
Company believes that it has earned a reputation for providing superior
customer service by consistently focusing on customer needs and service
innovation. The Company has won PC World's "World Class Award for Best
Mail Order Company" in seven out of the last eight years. The Company
delivers value to its customers through high quality service and
technical support provided by knowledgeable, well-trained personnel;
efficient and innovative delivery programs; in-house service
capabilities; competitive prices; and reasonable return policies.
. STRONG BRAND NAME AND CUSTOMER FRANCHISE. Since its founding in 1982,
the Company has built a strong brand name and customer franchise. In
July 1997, the Company was one of only two direct resellers included in
the "100 Most Influential Companies in the Computer Industry" by PC
Magazine. Its mailing list includes approximately 2,000,000 names, of
which approximately 500,000 have purchased products from the Company
during the last 12 months.
. BROAD PRODUCT SELECTION AT COMPETITIVE PRICES. The Company offers its
customers a wide assortment of personal computers and related products
at competitive price points. The Company's merchandising programs
feature products that provide customers with aggressive
price/performance and the convenience of one-stop shopping for their
personal computer and related needs.
. LONG-STANDING VENDOR RELATIONSHIPS. The Company has a history of strong
relationships with vendors, being among the first direct marketers
qualified by manufacturers to market systems to end users. The Company
provides its vendors with information concerning customer preferences
and an efficient channel for the advertising and distribution of their
products.
GROWTH STRATEGIES
The Company's growth strategies are to increase penetration of its existing
customer base, broaden its product offerings and expand its customer base. The
key elements of its strategies include:
. INCREASE OUTBOUND TELEMARKETING. The Company plans to increase
significantly the number of its corporate outbound account managers and
assign them to a higher percentage of the Company's customers. Outbound
account managers focus exclusively on serving specifically assigned
customers and seek to develop a close relationship with those customers
by identifying and responding to their needs for personal computers and
related products.
. EXPAND PRODUCT OFFERINGS. The Company continually evaluates personal
computers and related products focused on business users, adding new
products as they become available or in response to customer demand. The
Company is also expanding the breadth of offered products to include
items such as network servers, telecopiers and telephone equipment. It
works closely with vendors to identify and source first-to-market
product offerings at aggressive price points, and believes that
expansion of its corporate outbound marketing program will enhance its
access to such product offerings.
. TARGET CUSTOMER SEGMENTS. Through targeted mailings, the Company seeks
to expand the number of its active customers and generate additional
sales from its existing customers on a cost-effective basis. The Company
has developed specialty catalogs, as well as standard catalogs with
special cover pages, featuring product offerings designed to address the
needs of specific customer segments. The
28
<PAGE>
Company plans to further focus its product mix and catalogs to better
service the needs of its existing and prospective business customers,
including new product inserts targeted to purchasers of graphics, server
and networking products.
. DEVELOP ELECTRONIC COMMERCE CHANNEL. The Company's Internet Web-based
catalog provides detailed product descriptions, product search
capabilities and on-line order processing. The Company believes that an
increasing number of customers and potential new customers will elect to
shop electronically in the future and therefore it plans additional
investments to further improve the on-line sales capabilities, customer
service and product information and support available on its Internet
Web site.
SERVICE AND SUPPORT
Since its founding in 1982, the Company's primary objective has been to
provide products that meet the demands and needs of customers and to
supplement those products with up-to-date product information and excellent
customer service and support. The Company believes that offering its customers
superior value, through a combination of product knowledge, consistent and
reliable service and leading products at competitive prices, differentiates it
from other direct marketers and has become the foundation for developing a
broad and loyal customer base. The Company has introduced programs such as
Toll-Free Technical Support in 1982, the Everything Overnight(R) delivery
program in 1988, Money Back Guarantees in 1989, One-Minute Mail Order(R) in
1991 and its On-line Superstore in 1997.
The Company invests heavily in training programs for its service and support
personnel, with an emphasis on putting customer needs and service first.
Customer service representatives are available 24 hours a day, seven days a
week to handle orders, product information and general inquiries (including
the most frequently asked technical support questions).
The effectiveness of the Company's strategy is reflected in the recognition
accorded the Company, including the Company's receipt of PC World's "World
Class Award for Best Mail Order Company" in 1997, as voted by its readers, for
seven of the last eight years and receipt of the highest ranking of only two
direct resellers included in the first-ever ranking of the "100 Most
Influential Companies in the Computer Industry" by PC Magazine in July 1997.
Technical Support. The Company provides toll-free technical support from 9
a.m. through 5 p.m. Monday through Friday. Product support technicians assist
callers with questions concerning compatibility, installation, determination
of defects and more difficult questions of product use. The product support
technicians authorize customers to return defective or incompatible products
to either the manufacturer or to the Company for warranty service. In house
technicians are authorized for both warranty and non-warranty repair on most
major systems and hardware products.
Innovative Delivery Programs. Using the Company's customized information
system, the Company, upon receipt of customer orders, sends them to its
distribution center for processing immediately after they are credit approved.
Through its Everything Overnight(R) service, the Company guarantees that all
orders accepted up until 2:45 a.m. (until midnight on most custom-configured
systems) will be shipped for overnight delivery via Airborne Express.
MARKETING AND SALES
The Company sells its products through the direct marketing channel,
primarily to SMORGS. The Company's marketing objectives are to be the primary
supplier of personal computers and related products to its existing customers
and to expand its customer base. The Company employs multiple marketing
approaches to reach existing and prospective customers, including outbound
telemarketing, catalogs and inbound telesales, Web and print media
advertising, and specialty marketing programs. All of its marketing approaches
emphasize the Company's broad product offerings, fast delivery, customer
support, competitive pricing and multiple payment options.
29
<PAGE>
The Company believes that its ability to establish and maintain long-term
customer relationships and to encourage repeat purchases is largely dependent
on the strength of its telemarketing personnel and programs. Because its
customers' primary contact with the Company is through its telemarketers, the
Company is committed to maintaining a qualified, knowledgeable and motivated
sales staff with its principal focus on customer service.
Outbound Telemarketing. The Company seeks to build loyal relationships with
its potential high-volume customers by assigning them to individual account
managers. The Company believes that customers respond favorably to a one-on-
one relationship with personalized, well-trained account managers. Once
established, these one-on-one relationships are maintained and enhanced
through frequent telecommunications and targeted catalogs and other marketing
materials designed to meet each customer's specific computing needs.
Account managers focus exclusively on their managed accounts and on outbound
sales calls to prospective customers. The Company generally recruits account
managers from its inbound telemarketing staff and from other sales
organizations. All account managers must successfully complete a one-month
training program, which includes instruction in the Company's product
offerings and order management systems, as well as selling skills and account
management. Thereafter, new account managers are assigned to sales teams where
they receive intensive coaching and supervision by experienced supervisors,
and periodic refresher training from the sales training staff. Additional
training and product education programs are provided continuously through
vendor supported programs. The Company pays its account managers a base annual
salary plus incentive compensation which is tied to sales volume and gross
profit dollars produced. The Company imposes specific increases in sales
targets for incentive pay. Account managers historically have significantly
increased productivity after approximately 12 months of training and
experience. At December 31, 1997, the Company employed 155 account managers,
including 90 with less than 12 months of outbound telemarketing experience
with the Company.
Catalogs and Inbound Telesales. The Company's two principal catalogs are PC
Connection(R) for the PC market and MacConnection(R) for the Mac market. The
Company publishes twelve editions of each of these catalogs annually. The
Company distributes catalogs to purchasers on its in-house mailing list as
well as to other prospective customers. It sends its two principal catalogs to
its best customers twice each month. The initial mailing each month, labeled
an "early edition," is sent simultaneously to the best customers throughout
the United States and features special offers, such as first-to-market product
offerings, highlighted on the cover. The Company also includes a catalog with
each order shipped.
In addition, the Company mails specialty catalogs or customized versions of
its catalogs to selected customers. The Company distributes specialty catalogs
to educational customers and prospects on a periodic basis. The Company also
distributes its monthly catalogs customized with special covers and inserts,
offering a wider assortment of special offers on products in specific areas
(such as graphics, server/netcom and mobile computing) or for specific
customers (such as developers). These customized catalogs are distributed to
targeted customers included in the Company's customer database using past
identification or purchase history, as well as to outside mailing lists.
Each catalog is printed with full-color photographs, detailed product
descriptions and manufacturer specifications. The catalogs are primarily
created by in-house designers and production artists on a computer-based
desktop publishing system. The in-house preparation of most portions of the
catalog expedites the production process, providing for greater flexibility
and creativity in catalog production, allowing for last-minute changes in
pricing and format, and resulting in significant cost savings. After
completion of the design and preparation, the catalogs are outsourced for
printing by commercial printers.
The Company employs inbound sales representatives to answer customer
telephone calls generated by the Company's catalog, magazine and other
advertising programs and to assist customers in purchasing decisions, process
product orders and respond to customer inquiries on order status, product
pricing and availability. In late 1995, the Company initiated programs to
increase training of inbound telemarketing personnel and to provide
30
<PAGE>
incentive compensation based upon sales productivity. The Company employs a
flexible staffing model which allows it to maintain excellent customer service
during periods of peak demand while maintaining an efficient cost structure.
The Company regularly monitors calls for quality assurance purposes. It has
been a pioneer in using caller identification for the instant retrieval of
customer records. Employing proprietary information systems, sales
representatives can quickly access customer records which detail purchase
history and billing and shipping information, expediting the ordering process.
In addition to receiving orders through the Company's toll-free numbers,
orders are also received via fax, mail, and electronic mail.
Advertising. The Company advertises in selected personal computer and trade
magazines, such as PC Magazine, PC World and Macworld. These advertisements
provide product descriptions, manufacturers' specifications and pricing
information, and emphasize the Company's service and support features.
Additionally, the PC Connection(R) logo and telephone number are included in
promotions by selected manufacturers. The Company also advertises its Internet
Web site through independent content providers on commercial on-line services
such as Yahoo.
www.pcconnection.com. In November 1996, the Company launched an Internet Web
site, including a complete product catalog. In July 1997, the Company began
accepting electronic orders through its Internet Web site. Product
descriptions and prices of all products are provided on-line, with full,
updated information for over 7,000 items and on screen images available for
over 800 items. The Company offers, and continuously updates, selected product
offerings and other special buys. The Company believes that in the future its
Internet Web site will be an important sales source and communication tool for
improving customer service.
Specialty Marketing. The Company's specialty marketing activities include
direct mail, other inbound and outbound telemarketing services, bulletin board
services, "fax on demand" services, package inserts, fax broadcasts and
electronic mail. The Company also markets call-answering and fulfillment
services to certain of its product vendors such as Iomega Corporation.
Customers. The Company currently maintains an extensive database of
customers and prospects aggregating approximately 2,000,000 names. During the
year ended December 31, 1997, the Company received orders from approximately
500,000 customers. Approximately 65% of the Company's net sales in the year
ended December 31, 1997 were made to customers who had previously purchased
products from the Company.
PRODUCTS AND MERCHANDISING
The Company continuously focuses on expanding the breadth of its product
offerings. The Company currently offers approximately 15,000 personal computer
products designed for business applications from over 1,000 manufacturers,
including hardware and peripherals, accessories, networking products and
software. The Company offers both PCs and Macs and related products. In 1997,
sales of PCs and related products were approximately 78% of the Company's net
sales. The Company selects the products that it sells based upon their
technology and effectiveness, market demand, product features, quality, price,
margins and warranties. As part of its merchandising strategy, the Company
also offers new types of products related to PCs, such as digital cameras.
Computer systems/memory are the fastest growing product category,
representing 42.2% of net sales in the year ended December 31, 1997, up from
25.4% and 34.8% of net sales in the years ended December 31, 1995 and 1996,
respectively. The growth in system sales has been driven primarily by
increased outbound sales efforts to business customers and the aggressive
sourcing and merchandising of new computer systems lines and products.
The following table sets forth the Company's percentage of net sales (in
dollars) of computer systems/memory, peripherals, software, and networking and
communications products during the years ended December 31, 1995, 1996 and
1997.
31
<PAGE>
<TABLE>
<CAPTION>
PERCENTAGE OF NET SALES
--------------------------------------
YEAR YEAR YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
PRODUCT CATEGORIES 1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Computer Systems/Memory.................. 25.4% 34.8% 42.2%
Peripherals.............................. 39.4% 38.0% 34.3%
Software................................. 23.4% 17.6% 15.8%
Networking and Communications............ 11.8% 9.6% 7.7%
</TABLE>
The Company offers a limited 30-day money back guarantee for most unopened
products and selected opened products, although selected products are subject
to restocking fees. Substantially all of the products marketed by the Company
are warranted by the manufacturer. The Company generally accepts returns
directly from the customer and then either credits the customer's account or
ships the customer a similar product from the Company's inventory.
PURCHASING AND VENDOR RELATIONS
For the year ended December 31, 1997, the Company purchased approximately
50% of its products directly from manufacturers and the balance from
distributors and aggregators, all of which shipped products directly to the
Company's distribution facility in Wilmington, Ohio. During the years ended
December 31, 1996 and 1997, product purchases from Ingram Micro, the Company's
largest vendor, accounted for approximately 28.4% and 28.0%, respectively, of
the Company's total product purchases. No other vendor accounted for more than
10% of the Company's total product purchases. The Company believes that
alternative sources for products obtained from Ingram Micro are available.
Many product suppliers reimburse the Company for advertisements or other
cooperative marketing programs in the Company's catalogs or Company
advertisements in personal computer magazines that feature a manufacturer's
product. Reimbursements may be in the form of discounts, advertising
allowances and/or rebates. The Company also receives reimbursements from
certain vendors based upon the volume of purchases or sales of the vendors'
products by the Company. Historically, the Company received price protection
from its vendors on a majority of the products it sold. Protection takes the
form of rebates or credits against future purchases. The Company may
participate in the future in end-of-life-cycle and other special purchases
which may not be eligible for price protection.
The Company believes that it has excellent relationships with vendors,
generally pays vendors within stated terms and takes advantage of all
appropriate discounts. The Company believes that because of its volume
purchases it is able to obtain product pricing and terms that are competitive
with those available to other major direct marketers. Although brand names and
individual product offerings are important to the Company's business, the
Company believes that competitive sources of supply are available in
substantially all of the merchandise categories carried by the Company.
DISTRIBUTION
At its approximately 102,000 square foot distribution and fulfillment center
in Wilmington, Ohio, the Company receives and ships inventory, configures
computer systems and processes returned products. The Company also maintains a
related 25,700 square foot warehouse for inventory in nearby Xenia, Ohio.
Orders are transmitted electronically from the Company's New Hampshire sales
facilities to its Wilmington distribution center after credit approval, where
packing documentation is printed automatically and order fulfillment takes
place. The Company guarantees that all orders accepted up until 2:45 a.m.
(until midnight on custom-configured systems) will be shipped for overnight
delivery via Airborne Express. It ships approximately 90% of its orders
through Airborne Express. Upon request, orders may also be shipped by other
common carriers.
The Company configures approximately half of the computer systems it sells.
Configuration typically consists of the installation of memory, accessories
and/or software.
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<PAGE>
While the Company believes that its existing distribution facilities in
Wilmington and Xenia, Ohio will be sufficient to support the Company's
anticipated needs through the next 12 months, it is evaluating additional
and/or alternative facilities for distribution and inventory to support future
growth.
MANAGEMENT INFORMATION SYSTEMS
The Company uses management information systems, principally comprised of
applications software running on IBM AS/400 and RS6000 computers and Microsoft
NT-based servers, which the Company has customized for its use. These systems
permit centralized management of key functions, including order taking and
processing, inventory and accounts receivable management, purchasing, sales
and distribution, and the preparation of daily operating control reports on
key aspects of the business. The Company also operates advanced
telecommunications equipment to support its sales and customer service
operations. Key elements of the telecommunications systems are integrated with
the Company's computer systems to provide timely customer information to sales
and service representatives, and to facilitate the preparation of operating
and performance data. The Company believes that its customized information
systems enable the Company to improve its productivity, ship customer orders
on a same-day basis, respond quickly to changes in its industry and provide
high levels of customer service.
The Company's success is dependent in large part on the accuracy and proper
use of its information systems, including its telephone systems, to manage its
inventory and accounts receivable collections, to purchase, sell and ship its
products efficiently and on a timely basis, and to maintain cost-efficient
operations. The Company expects to continually upgrade its information systems
to more effectively manage its operations and customer database, including to
be Year 2000 compliant. In that regard, it is in the process of converting to
new software for its order management and fulfillment systems designed to be
Year 2000 compliant, which is expected to be completed by the first half of
1998.
COMPETITION
The direct marketing and sale of personal computers and related products is
highly competitive. PC Connection competes with other direct marketers of
personal computers and related products, including CDW Computer Centers, Inc.,
Insight Enterprises, Inc. and Micro Warehouse, Inc. The Company also competes
with certain product manufacturers that sell directly to customers, such as
Dell Computer Corporation and Gateway 2000, Inc., and more recently Compaq,
IBM and Apple; distributors that sell directly to certain customers, such as
MicroAge, Inc. and Vanstar Corporation; various cost-plus aggregators,
franchisers, and national computer retailers, such as CompUSA, Inc. and
Computer City; and companies with an Internet Web site and commercial on-line
networks. Additional competition may arise if other new methods of
distribution, such as broadband electronic software distribution, emerge in
the future.
The Company competes not only for customers, but also for favorable product
allocations and cooperative advertising support from product manufacturers.
Several of the Company's competitors are larger and have substantially greater
financial resources than the Company.
The Company believes that price, product selection and availability, and
service and support are the most important competitive factors in its
industry.
INTELLECTUAL PROPERTY RIGHTS
The Company conducts its business under the marks PC Connection(R) and
MacConnection(R) and their related logos. Other Company trademarks and service
marks include Everything Overnight(R), One-Minute Mail Order(R), PC & Mac
Connection(R), Systems Connection(R), The Connection(R), Raccoon Character(R),
Service Connection(TM), Graphics Connection(TM), and Memory Connection(TM).
The Company intends to use and protect these and its other marks, as it deems
necessary. The Company believes its trademarks and service marks have
significant value and are an important factor in the marketing of its
products. The Company does not maintain a
33
<PAGE>
traditional research and development group, but works closely with computer
product manufacturers and other technology developers to stay abreast of the
latest developments in computer technology, both with respect to the products
it sells and the products it uses to conduct its business.
EMPLOYEES
As of December 31, 1997, the Company employed 890 persons, of whom 394 were
engaged in sales related activities, 85 were engaged in providing customer
service and support, 209 were engaged in purchasing and distribution related
activities, 57 were engaged in the operation and development of management
information systems, and 145 were engaged in administrative and accounting
functions. The Company considers its employee relations to be good. The
Company's employees are not represented by a labor union, and it has
experienced no work stoppages since inception.
FACILITIES
The Company's principal facilities, all of which are leased, are as follows:
<TABLE>
<CAPTION>
Approx.
Facility Location Sq. Ft. Expiration of Lease
-------- -------------- ------- -------------------
<S> <C> <C> <C>
Corporate Headquarters............... Milford, NH 84,000 July 1998(1)
Sales and Service Facility........... Keene, NH 22,000 July 2008
Sales Facility....................... Hudson, NH 8,300 August 1998(2)
Conference Center.................... Marlow, NH 15,800 May 2007
Distribution Center.................. Wilmington, OH 102,000 December 2000
Distribution Facility................ Xenia, OH 25,700 September 1998(3)
</TABLE>
- ---------------------
(1) The Company has entered into a fifteen year lease for a new corporate
headquarters which the Company plans to occupy in the summer of 1998. See
"Certain Transactions."
(2) The Company has the option to renew the lease for this facility annually
for one-year periods through August 2002.
(3) The Company has the option to renew the lease for this facility annually
for one-year periods through September 2000.
Several of these facilities are leased from affiliated entities. See
"Certain Transactions."
While the Company believes that its existing facilities in Wilmington and
Xenia, Ohio will be sufficient to support the Company's anticipated needs
through the next 12 months, it is evaluating additional and/or alternative
facilities for distribution and inventory to support future growth.
REGULATORY AND LEGAL MATTERS
The direct response business conducted by the Company is subject to the Mail
or Telephone Order Merchandise Rule and related regulations promulgated by the
Federal Trade Commission. While the Company believes it is in compliance with
such regulations, no assurance can be given that new laws or regulations will
not be enacted or adopted that might adversely affect the Company's
operations. There are no material legal proceedings pending against the
Company.
34
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their ages as of
January 31, 1998 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Patricia Gallup............... 43 Chairman of the Board and Chief Executive
Officer
David Hall.................... 48 Vice Chairman of the Board
Wayne L. Wilson............... 48 President, Chief Operating Officer and Chief
Financial Officer
Robert F. Wilkins............. 36 Senior Vice President of Merchandising and
Product Management
R. Wayne Roland............... 49 Vice President of Fulfillment Operations
John L. Bomba, Jr. ........... 44 Vice President of Information Services and
Chief Information Officer
Tracey Thompson Turner........ 40 Vice President of Corporate Communications
David B. Beffa-Negrini........ 44 Vice President of Media Development and
Director
Martin C. Murrer(1)........... 40 Director
Peter J. Baxter(1)............ 46 Director
</TABLE>
- ---------------------
(1) Member of Compensation Committee and Audit Committee.
Patricia Gallup is a co-founder of the Company and has served as Chairman of
the Board and Chief Executive Officer of the Company since January 1998. From
September 1995 to January 1998, Ms. Gallup served as the Chairman of the
Board, President and Chief Executive Officer of the Company. From September
1994 to September 1995, she served as Chairman of the Board and Chief
Executive Officer of the Company. From August 1990 to September 1994, Ms.
Gallup served as the Company's President and Chief Executive Officer.
David Hall is a co-founder of the Company and has served as Vice Chairman of
the Board since November 1997. From June 1997 to November 1997, Mr. Hall
served as the Vice Chairman of the Board, Executive Vice President and
Treasurer of the Company. From February 1995 to June 1997, Mr. Hall served as
the Company's Vice Chairman of the Board and Executive Vice President. From
March 1991 to February 1995, he served as the Executive Vice President of the
Company.
Wayne L. Wilson has served as President, Chief Operating Officer and Chief
Financial Officer of the Company since January 1998. From January 1996 to
January 1998, Mr. Wilson served as Senior Vice President, Chief Operating
Officer and Chief Financial Officer of the Company. From August 1995 to
January 1996, he served as Senior Vice President of Finance and Chief
Financial Officer of the Company. Prior to joining the Company, Mr. Wilson was
a partner in the accounting and consulting firm of Deloitte & Touche LLP from
June 1986 to August 1995.
Robert F. Wilkins has served as Senior Vice President of Merchandising and
Product Management of the Company since January 1998. From December 1995 to
January 1998, Mr. Wilkins served as Vice President of Merchandising and
Product Management of the Company. From September 1994 to December 1995, he
was a consultant to the Company and certain of its affiliates. From February
1990 to September 1994, Mr. Wilkins served as President of Mac's Place.
R. Wayne Roland has served as Vice President of Fulfillment Operations of
the Company since March 1996. From June 1995 to March 1996, he was a
consultant to the Company. From July 1990 to June 1995, Mr. Roland served as
controller and then as Director of Strategic Projects for Brookstone, Inc.
John L. Bomba, Jr. has served as Vice President of Information Services and
Chief Information Officer of the Company since May 1997. From May 1994 to
April 1997, Mr. Bomba served as Director of Worldwide Information Systems for
Micro Warehouse, Inc. Prior to May 1994, he served as Director of Professional
Services for Innovative Information Systems, Inc.
35
<PAGE>
Tracey Thompson Turner has served as Vice President of Corporate
Communications since November 1997. From March 1990 to August 1997, Ms. Turner
served as Vice President of Corporate Communications and Investor Relations
for Healthsource, Inc.
David B. Beffa-Negrini has served on the Company's Board of Directors since
September 1994 and as the Vice President of Media Development since January
1998. From January 1992 to January 1998, Mr. Beffa-Negrini served as the
Company's Director of Merchandising.
Martin C. Murrer has served on the Company's Board of Directors since April
1995. Since January 1997, Mr. Murrer has been a managing director of
Donaldson, Lufkin & Jenrette Securities Corporation. From June 1995 to January
1997, Mr. Murrer was a Senior Vice President of Donaldson, Lufkin & Jenrette
Securities Corporation. From June 1990 to June 1995, Mr. Murrer was a Vice
President of Goldman, Sachs & Co.
Peter J. Baxter has served on the Company's Board of Directors since
September 1997. Mr. Baxter has been the President, Chief Executive Officer and
a director of CFX Corporation, a bank holding company, since January 1989.
There are no family relationships among any of the directors and executive
officers of the Company. Officers serve at the discretion of the Board of
Directors of the Company (the "Board").
COMMITTEES OF THE BOARD
The Board has established a Compensation Committee and an Audit Committee,
each comprised of Messrs. Murrer and Baxter. The Compensation Committee makes
recommendations concerning salaries and incentive compensation for employees
of and consultants to the Company and administers the Company's incentive
plans. The Audit Committee reviews the results and scope of the audit and
other services provided by the Company's independent public accountants.
COMPENSATION OF DIRECTORS
Non-employee members of the Board and Mr. Beffa-Negrini, an employee
director of the Company, receive a $15,000 annual retainer and fees of $1,000
for each Board meeting attended and $500 for each Board committee meeting
attended on a day other than the day of the Board meeting, as well as
reimbursement for all reasonable expenses incurred in attending Board and
committee meetings. Mr. Murrer has waived payment of his director's fees and
in lieu thereof the Company has established a grant program pursuant to which
a donee selected by Mr. Murrer can purchase products having a value equal to
the amount of the waived fees.
EXECUTIVE COMPENSATION
Summary Compensation. The following table sets forth compensation paid to
the Chief Executive Officer and each of the four other most highly compensated
individuals who served as executive officers on December 31, 1997 and who
received over $100,000 in compensation for services rendered to the Company in
all capacities during the fiscal year ended December 31, 1997 (the "Named
Executive Officers").
36
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
1997 ANNUAL COMPENSATION COMPENSATION
------------------------------------- ---------------------
AWARDS
---------------------
NAME AND OTHER ANNUAL SECURITIES UNDERLYING ALL OTHER
PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($) OPTIONS (#) COMPENSATION($)
- ------------------ --------- -------- --------------- --------------------- ---------------
<S> <C> <C> <C> <C> <C>
Patricia Gallup ........ $240,000 $ -- $6,065,000(2) -- $2,250(3)
Chairman of the Board 408(4)
and Chief Executive
Officer(1)
David Hall.............. 240,000 -- 6,065,000(2) -- 2,250(3)
Vice Chairman of the 696(4)
Board
Wayne L. Wilson......... 280,000 200,000(6) -- 65,549 696(4)
President, Chief
Operating Officer and
Chief Financial
Officer(5)
Robert F. Wilkins....... 175,000 142,500(6) -- 78,659 2,250(3)
Senior Vice President 264(4)
of Merchandising and
Product Management(7)
R. Wayne Roland......... 140,000 120,000(6) -- 39,329 2,250(3)
Vice President of 696(4)
Fulfillment Operations
</TABLE>
- ---------------------
(1) During the year ended December 31, 1997, Ms. Gallup served as the Chairman
of the Board, President and Chief Executive Officer.
(2) Represents amounts accrued or distributed for Company-related federal
income tax obligations payable by the stockholders.
(3) Represents the Company's 401(k) profit-sharing plan matching contribution.
(4) Represents premiums paid by the Company on life insurance with policy
amounts in excess of $50,000 for the Named Executive Officer.
(5) During the year ended December 31, 1997, Mr. Wilson served as the Senior
Vice President, Chief Operating Officer and Chief Financial Officer of the
Company.
(6) Includes amounts paid in 1998 to the Named Executive Officer earned in
1997.
(7) During the year ended December 31, 1997, Mr. Wilkins served as the Vice
President of Merchandising and Product Management.
Employment and Severance Agreements.
In January 1998, the Company entered into employment agreements with
Patricia Gallup as Chairman of the Board and Chief Executive Officer, and with
David Hall as Vice Chairman of the Board. Pursuant to these agreements, each
of Ms. Gallup and Mr. Hall has agreed to perform the duties she or he
performed prior to the execution of such agreements for an annual base salary
of $300,000 for the year ending December 31, 1998. These agreements may be
terminated by the Company or by the employee at any time.
In August 1995, the Company entered into an employment agreement with Wayne
L. Wilson, pursuant to which he is currently serving as President, Chief
Operating Officer and Chief Financial Officer, providing for an initial annual
base salary of $230,000. In addition, the agreement provided for (i) initial
deferred incentive compensation up to $70,000 a year; (ii) additional
compensation up to $12,500 in each of the first two fiscal quarters of his
employment; and (iii) the grant of options to acquire 65,549 shares of Non-
Voting Common Stock under the Company's 1993 Incentive and Non-Statutory Stock
Option Plan. See "--Stock Plans." Upon termination of his employment by the
Company without cause, Mr. Wilson shall be entitled to severance payments
totaling his annual base salary as of the date of the termination of his
employment.
In December 1995, the Company entered into an employment agreement with
Robert F. Wilkins, pursuant to which he is currently serving as Senior Vice
President of Merchandising and Product Management. The
37
<PAGE>
agreement provides for an initial annual base salary of $140,000 and initial
annual incentive compensation of up to $60,000, based upon the achievement of
certain performance goals. If Mr. Wilkins is terminated by the Company without
cause, he is entitled to severance payments equal to one-half of his annual
base salary as of the date of the termination of his employment.
In March 1997, the Company entered into a letter agreement with R. Wayne
Roland, providing for a severance payment equal to one-half of his then
applicable annual base salary if the Company terminates his employment for any
reason other than for cause. Mr. Roland currently holds the position of Vice
President of Fulfillment Operations.
Option Grants. The following table sets forth information concerning stock
options granted in the year ended December 31, 1997 to the Named Executive
Officers.
OPTION GRANTS IN FISCAL 1997
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM(2)
------------------------------------------ -----------------------
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES EXERCISE
OPTIONS IN FISCAL PRICE EXPIRATION
NAME GRANTED (#) YEAR ($/SH) DATE(1) 0%($) 5%($) 10%($)
- ---- ----------- ---------- -------- ---------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Patricia Gallup......... -- -- -- -- -- -- --
David Hall.............. -- -- -- -- -- -- --
Wayne L. Wilson......... 65,549 13.0 3.81 1/1/2007 70,793 272,375 581,643
Robert F. Wilkins....... 78,659 15.6 3.81 1/1/2007 84,952 326,851 697,973
R. Wayne Roland......... 39,329 7.8 5.72 7/1/2007 127,819 349,681 690,062
</TABLE>
- ---------------------
(1) Options may terminate before their expiration date if the optionee's
status as an employee or consultant is terminated or upon optionee's
death.
(2) The 0%, 5% and 10% assumed annual compound rates of stock price
appreciation are mandated by the rules of the Securities and Exchange
Commission and do not represent the Company's estimated projection of
future prices of its securities. In calculating the potential realizable
value the Company used fair market value at the dates of grant as
determined by the Board.
Option Exercises and Options Outstanding. The following table sets forth the
number of shares covered by both exercisable and unexercisable stock options
as of December 31, 1997 for the Named Executive Officers. Also reported are
the values for "in the money" options, which represent the positive spread
between the exercise prices of any such existing stock options and the fair
market value of the Company's Common Stock as of December 31, 1997.
AGGREGATE OPTION EXERCISES IN FISCAL 1997
AND DECEMBER 31, 1997 OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
ACQUIRED OPTIONS AT IN-THE-MONEY OPTIONS AT
ON VALUE DECEMBER 31, 1997 DECEMBER 31, 1997($)(1)
EXERCISE REALIZED ------------------------- -------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Patricia Gallup......... -- -- -- -- -- --
David Hall.............. -- -- -- -- -- --
Wayne L. Wilson......... -- -- -- 196,647 -- 2,471,345
Robert F. Wilkins....... -- -- -- 131,098 -- 1,627,563
R. Wayne Roland......... -- -- -- 39,329 -- 404,269
</TABLE>
- ---------------------
(1) Calculated by determining the difference between the fair market value of
the securities underlying the option at December 31, 1997 (as determined
by the Board) and the exercise price of the options.
38
<PAGE>
STOCK PLANS
1993 Incentive and Non-Statutory Stock Option Plan.
The Company's 1993 Incentive and Non-Statutory Stock Option Plan (the "1993
Option Plan") was approved by the Board of Directors and the stockholders in
December 1993. At December 31, 1997, options to purchase a total of 1,094,010
shares of Company Common Stock were outstanding at a weighted average exercise
price of $3.31 per share under the 1993 Option Plan, and 30,153 shares of
Company Common Stock were reserved for issuance under the 1993 Option Plan,
and were granted in January 1998.
The 1993 Option Plan provides for the grant of incentive stock options and
non-statutory stock options to employees, consultants, directors and officers.
The exercise price of all incentive stock options granted under the 1993
Option Plan must be at least equal to the fair market value per share of
Company Common Stock on the date of grant or 110% of the fair market value for
stockholders holding greater than 10% of the Company's Common Stock. The terms
of options granted under the 1993 Option Plan may not exceed ten years and
options granted to stockholders holding greater than 10% of the Voting Common
Stock may not exceed five years. In the event of termination of an optionee's
employment or consulting arrangement, options may only be exercised, to the
extent vested as of the date of termination, for a period not to exceed 30
days (180 days, in the case of termination as a result of death) following the
date of termination. Options may not be sold or transferred other than by will
or the laws of descent and distribution, and may be exercised during the life
of the optionee only by the optionee. Effective upon the consummation of the
Offering, the Company does not intend to grant any further options under the
1993 Option Plan.
1997 Stock Incentive Plan.
The Company's 1997 Stock Incentive Plan (the "1997 Stock Plan") provides for
the grant of incentive stock options (within the meaning of Section 422 of the
Code), non-statutory stock options, restricted stock, and other stock based
awards, including the grant of Shares based on certain conditions, the grant
of securities convertible into Common Stock and the grant of stock
appreciation rights ("Awards"). An aggregate of 800,000 shares of Common Stock
may be issued pursuant to the 1997 Stock Plan (subject to adjustment for
certain changes in the Company's capitalization).
The 1997 Stock Plan is administered by the Board and the Compensation
Committee. The Board has the authority to grant Awards under the 1997 Stock
Plan and to accelerate, waive or amend certain provisions of outstanding
Awards. The 1997 Stock Plan provides that, to the extent permitted by
applicable law, the Board may authorize the Compensation Committee to
administer certain aspects of the 1997 Stock Plan and subject to certain
limitations, may authorize the Chief Executive Officer or another officer of
the Company to grant Awards to certain employees.
Incentive Stock Options and Nonstatutory Options. Optionees receive the
right to purchase shares of Common Stock at a specified price in one or more
installments after the grant date, subject to such terms and conditions as are
specified at the time of the grant. Incentive stock options and options that
the Board or Compensation Committee intends to qualify as performance-based
compensation under Section 162(m) of the Code may not be granted at an
exercise price less than the fair market value of the Common Stock on the date
of grant (or less than 110% of the fair market value in the case of incentive
stock options granted to optionees holding 10% or more of the voting stock of
the Company). All other options may be granted at an exercise price that may
be less than, equal to or greater than the fair market value of the Common
Stock on the date of grant. No option shall be granted for a term in excess of
10 years.
Stock Appreciation Rights and Performance Shares. A stock appreciation right
("SAR") is based on the value of Common Stock and entitles the SAR holder to
receive consideration to the extent that the fair market value on the date of
exercise of the shares of Common Stock underlying the SAR exceeds the fair
market value of the underlying shares on the date the SAR was granted. A
performance share award entitles the recipient to acquire shares of Common
Stock upon the attainment of specified performance goals.
39
<PAGE>
Restricted Stock. Restricted stock awards entitle recipients to acquire
shares of Common Stock, subject to the right of the Company to repurchase all
or part of such shares at their purchase price from the recipient in the event
that the conditions specified in the applicable stock award are not satisfied
prior to the end of the applicable restriction period established for such
award.
All of the employees, officers, directors, consultants and advisors of the
Company who are expected to contribute to the Company's future growth and
success are eligible to participate in the 1997 Stock Plan.
Section 162(m) of the Code disallows a tax deduction to public companies for
certain compensation in excess of $1 million paid to the company's chief
executive officer or to any of the four other most highly compensated
executive officers. Certain compensation, including "performance-based
compensation," is not included in compensation subject to the $1 million
limitation. The 1997 Stock Plan limits to 250,000 (the "Award Limit") the
maximum number of shares of Common Stock with respect to which Awards may be
granted to any employee in any calender year. The Award Limit and certain
other provisions of the 1997 Stock Plan are intended to comply with the
"performance based compensation" exception to the deductibility limits of
Section 162(m) with respect to certain Awards.
1997 Employee Stock Purchase Plan.
The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan")
authorizes the issuance of up to an aggregate of 225,000 shares of Common
Stock to participating employees. The Company will make one or more offerings
("Plan Offerings") to employees to purchase Common Stock under the Purchase
Plan. Plan Offerings may be six months or one year in duration and will
commence on July 1 and January 1, commencing on January 1, 1999. During each
Plan Offering, the maximum number of shares which may be purchased by a
participating employee is determined on the first day of the Plan Offering
period under a formula whereby 85% of the market value of a share of Common
Stock on the first day of the Plan Offering period is divided into an amount
equal to 10% of the employee's annualized compensation (or such lower
percentage as may be established by the Compensation Committee) for the
immediately preceding period equivalent in length to the Plan Offering. An
employee may elect to have up to 10% deducted from his or her regular salary
(or such lower percentage as may be established by the Compensation Committee
for this purpose. The price at which an employee's option is exercised is the
lower of (i) 85% of the closing price of the Common Stock on the Nasdaq
National Market on the day that the Plan Offering commences or (ii) 85% of the
closing price on the Nasdaq National Market on the day that the Plan Offering
terminates.
The Purchase Plan is administered by the Board and the Compensation
Committee. With certain exceptions, all eligible employees, including
directors and officers, regularly employed by the Company for at least six
months on the applicable Plan Offering commencement date are eligible to
participate in the Purchase Plan. The Purchase Plan is intended to qualify as
an "employee stock purchase plan" as defined in Section 423 of the Code.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee reviews and approves compensation and benefits
for the Company's executive officers, and grants options to executive officers
under the 1997 Stock Plan. No interlocking relationship exists between any
member of the Compensation Committee and any member of any other company's
board of directors or compensation committee.
40
<PAGE>
CERTAIN TRANSACTIONS
Since inception, the Company has been privately held by the two principal
stockholders and, in all periods described in the Prospectus, has elected to
be treated as an S Corporation for federal and applicable state tax laws. As a
result, the principal stockholders have conducted activities and acquired
properties through other entities owned directly by them rather than through
the Company and such entities have entered into transactions with the Company.
The following description is a summary of the material portions of such
transactions. Following the consummation of the Offering, all transactions
described below, other than the leases of facilities, the Voting Trust
Agreement and the Registration Rights Agreement will terminate.
LEASES
The Company currently has leases for a facility in Marlow, New Hampshire and
a facility in Keene, New Hampshire with Gallup & Hall, a partnership ("G&H")
owned solely by Patricia Gallup and David Hall, the Company's principal
stockholders. The lease for the Keene, New Hampshire facility expires in July
2008 and requires annual rental payments of $144,600 (subject to annual
adjustment for changes in the consumer price index). The lease for the Marlow,
New Hampshire facility expires in May 2007 and requires annual rental payments
of $106,200 (subject to adjustment every three years for changes in the
consumer price index). These leases also obligate the Company to pay certain
real estate taxes and insurance premiums on the premises. Rent expense under
all such leases aggregated $236,000, $236,000 and $264,000 for the years ended
December 31, 1995, 1996 and 1997 respectively. The Company also leased an
additional facility in Marlow, New Hampshire from an entity owned 20% by David
Hall, which was terminated in 1996. Lease payments for such facility were
$25,000 and ($171,000) (net of a $200,000 lease termination payment received
by the Company) for the years ended December 31, 1995 and 1996, respectively.
The Company also leases several other buildings from G&H on a month-to-month
basis. Rent expense under all such leases aggregated $37,000, $46,000 and
$48,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
In November 1997, the Company entered into a fifteen-year lease for a new
103,000 square foot corporate headquarters in Merrimack, New Hampshire with
G&H Post, L.L.C., an entity owned solely by Patricia Gallup and David Hall.
The Company expects to occupy the new facility in the summer of 1998. Annual
lease payments under the terms of the lease will be $823,000, or approximately
$8.00 per square foot, for the first five years of the lease, increasing to
$926,000 for years six through ten and to $1.0 million for years 11 through
15. The lease requires the Company to pay its proportionate share of real
estate taxes and common area maintenance charges as additional rent and also
to pay insurance premiums for the leased property. The Company has the option
to renew the lease for two additional terms of five years each.
While the Company believes the terms of each of these leases are fair to the
Company, their terms were not negotiated on an arms-length basis and,
accordingly, there can be no assurance that the terms of each of the leases
are as favorable to the Company as those which could have been obtained from
independent third parties.
CERTAIN STOCKHOLDER LOANS
Prior to the Offering, Patricia Gallup and David Hall made loans to the
Company to fund working capital requirements. Such indebtedness bore interest
at 6% and was payable on demand. The maximum aggregate amount owed to Patricia
Gallup and David Hall at any time during the year ended December 31, 1995 was
$0.6 million. Such indebtedness was repaid in full during 1995. Interest
payments on such indebtedness were approximately $4,000 for the year ended
December 31, 1995.
VOTING TRUST
In connection with the Offering, Patricia Gallup and David Hall, the
Company's principal stockholders who will beneficially own or control, in the
aggregate, approximately 79% of the outstanding shares of Common
41
<PAGE>
Stock of the Company upon completion of the Offering, placed all except 40,000
of the shares of the Common Stock that they beneficially own, in the
aggregate, into a Voting Trust (the "Voting Trust") of which they serve as co-
trustees. The terms of the Voting Trust require that both of them, as co-
trustees, must agree as to the manner of voting the shares of Common Stock of
the Company held by the Voting Trust in order for the shares to be voted. In
the event the co-trustees are deadlocked with respect to the election of
directors at a meeting of stockholders, the Board may require the co-trustees
to execute and deliver to the Secretary of the Company a proxy representing
all shares issued and outstanding in the name of the Voting Trust and entitled
to vote in the election of directors. Such proxy shall confer upon the
proxyholder authority to attend the meeting for purposes of establishing a
quorum and to vote for the directors nominated by the Board, provided that
such nominees are incumbent directors elected with the consent of the co-
trustees. Each of Ms. Gallup and Mr. Hall may transfer shares of Common Stock
for value to unaffiliated third parties. Any shares so transferred will no
longer be subject to the Voting Trust and an equal number of the non-
transferring co-trustee's shares will be released from the Voting Trust.
Transfers by either of Ms. Gallup or Mr. Hall in excess of 50,000 shares in
any 90-day period, or that would decrease the shares held by the Voting Trust
to less than a majority of the outstanding shares, will be subject to a right
of first refusal in favor of the other. The Voting Trust will terminate when
it holds less than 10% of the outstanding shares of Common Stock of the
Company or at the death of both co-trustees. In addition, in the event of the
death or incapacity of either co-trustee, or when either of Ms. Gallup or Mr.
Hall holds less than 25% of the beneficial interest held by the other in the
Voting Trust, the other will become the sole trustee of the Voting Trust with
the right to vote all the shares held by the Voting Trust. See "Risk Factors--
Control by Principal Stockholders."
REGISTRATION RIGHTS AGREEMENT
In connection with the Offering, Patricia Gallup and David Hall entered into
a Registration Rights Agreement pursuant to which the Company granted to Ms.
Gallup and Mr. Hall demand and incidental, or "piggy-back," registration
rights with respect to the shares of Common Stock held by them. The demand
registration rights generally provide that Ms. Gallup or Mr. Hall may require,
subject to certain restrictions regarding timing and number of shares, that
the Company register under the Securities Act all or a portion of the shares
of Common Stock held by Ms. Gallup or Mr. Hall. In addition, upon the request
of Ms. Gallup or Mr. Hall, the Company will be required to file a "shelf"
registration statement covering their shares. Pursuant to the incidental
registration rights, the Company is required to notify Ms. Gallup and Mr. Hall
of any proposed registration of Common Stock under the Securities Act and, if
requested and subject to certain restrictions, to include in such registration
shares of Common Stock held by them or either of them. The Company will pay
all expenses, other than underwriting fees, discounts and commissions, and
indemnify Ms. Gallup and Mr. Hall against certain liabilities, included under
the Securities Act, in connection with any registration of Common Stock
pursuant to such agreement.
OTHER TRANSACTIONS WITH AFFILIATED COMPANIES
The Company purchased administrative support services from an affiliated
company owned solely by Patricia Gallup and David Hall. Amounts paid to such
company totaled $736,000 and $762,000 for the years ended December 31, 1996
and 1997, respectively. Subsequent to the Offering, the Company will not
purchase any services from such affiliate.
The Company purchased television advertising from an affiliated company
owned solely by Patricia Gallup and David Hall. Amounts paid to such company
totaled $77,000, $0 and $492,000 for the years ended December 31, 1995, 1996
and 1997, respectively. The Company does not expect to purchase any
advertising from such affiliate subsequent to the Offering.
The Company also purchased services from other affiliated entities
aggregating $3,000, $27,000 and $26,000 for the years ended December 31, 1995,
1996 and 1997, respectively.
The Company provided various management-related services to entities owned
solely by Patricia Gallup and David Hall, for which the Company received
$78,000 during the year ended December 31, 1995. The
42
<PAGE>
Company received no payments for these services during the year ended December
31, 1996 and 1997. The Company does not anticipate providing such services
subsequent to the Offering.
The Company sold certain property and equipment having net book values of
$30,000, $0 and $14,000 during the years ended December 31, 1995, 1996, and
1997, respectively, to affiliated companies owned solely by Patricia Gallup
and David Hall. Proceeds received with respect to these sales totaled $33,000,
$19,000 and $16,000 in 1995, 1996 and 1997, respectively.
S CORPORATION DISTRIBUTIONS AND RELATED DIVIDEND PAYABLE
The Company has made accruals or distributions of S Corporation earnings,
accounted for as additional compensation expense, to its stockholders. Such
accruals and distributions aggregated $1.3 million and $12.1 million for the
years ended December 31, 1996 and 1997, respectively. On February 27, 1998,
the Company declared a dividend of $2.80 per share (approximately $33.0
million in the aggregate) to its stockholders representing cumulative
undistributed S Corporation earnings through the date of the closing of the
Offering (at which time the Company's election to be treated as an S
Corporation will terminate). The Company expects to pay the dividend from the
net proceeds of the Offering. See "Use of Proceeds" and Note 12 to the
Financial Statements.
43
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's voting securities as of January 31, 1998, assuming
exercise of options that are vested and would be exercisable, assuming
consummation of the Offering and Reorganization, within 60 days of January 31,
1998, (i) by each person who, to the knowledge of the Company, beneficially
owns more than 5% of any class of the Company's voting securities; (ii) by
each director of the Company; (iii) by each Named Executive Officer of the
Company named under "Management--Executive Compensation--Summary Compensation
Table," and (iv) by all directors and officers of the Company as a group. The
address for all executive officers and directors is c/o PC Connection, Inc.,
528 Route 13, Milford, New Hampshire 03055.
<TABLE>
<CAPTION>
PERCENT OWNERSHIP
SHARES ----------------------
BENEFICIALLY BEFORE THE AFTER THE
NAME OWNED(1) OFFERING OFFERING(1)
- ---- ------------ ---------- -----------
<S> <C> <C> <C>
Patricia Gallup(2)........................ 5,899,397 50.0% 39.5%
David Hall(3)............................. 5,899,396 50.0% 39.5%
Wayne L. Wilson(4)........................ 163,872 1.4% 1.1%
Robert F. Wilkins(5)...................... 85,214 * *
R. Wayne Roland(6)........................ 13,110 * *
David Beffa-Negrini(7).................... 229,421 1.9% 1.5%
Martin C. Murrer(8)....................... 65,549 * *
Peter J. Baxter........................... -- -- --
All executive officers and directors as a
group (ten persons)(9)................... 12,355,959 100.0% 79.8%
</TABLE>
- ---------------------
* Less than one percent
(1) Reflects the Reincorporation.
(2) Includes 1,474,849 shares held of record by Gallup PC Connection Stock
Trust FOB Patricia Gallup. This Stock Trust was dissolved in connection
with the Reorganization and formation of the Voting Trust.
(3) Includes 1,474,849 shares held of record by Hall PC Connection Stock Trust
FOB David Hall. This Stock Trust was dissolved in connection with the
Reorganization and formation of the Voting Trust.
(4) Consists of 163,872 shares issuable upon exercise of stock options that
are vested and would be exercisable, assuming consummation of the
Offering, within 60 days of January 31, 1998.
(5) Consists of 85,214 shares issuable upon exercise of stock options that are
vested and would be exercisable, assuming consummation of the Offering,
within 60 days of January 31, 1998.
(6) Consists of 13,110 shares issuable upon exercise of stock options that are
vested and would be exercisable, assuming consummation of the Offering,
within 60 days of January 31, 1998.
(7) Consists of 229,421 shares issuable upon exercise of stock options that
are vested and would be exercisable, assuming consummation of the
Offering, within 60 days of January 31, 1998.
(8) Consists of 65,549 shares issuable upon exercise of stock options that are
vested and would be exercisable, assuming consummation of the Offering,
within 60 days of January 31, 1998.
(9) Includes 557,166 shares issuable upon exercise of stock options that are
vested and would be exercisable, assuming consummation of the Offering,
within 60 days of January 31, 1998.
44
<PAGE>
DESCRIPTION OF CAPITAL STOCK
As of January 31, 1998 (after giving effect to the Reorganization), there
were outstanding an aggregate of 11,798,793 shares of Common Stock held of
record by four stockholders.
COMMON STOCK
The Company's Amended and Restated Certificate of Incorporation (the
"Restated Certificate") authorizes the issuance of up to 30,000,000 shares of
Common Stock. Holders of Common Stock are entitled to one vote for each share
held on all matters submitted to a vote of stockholders and do not have
cumulative voting rights. Accordingly, holders of a majority of the shares of
Common Stock entitled to vote in any election of directors may elect all of
the directors standing for election. Holders of Common Stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board out of
funds legally available therefore, subject to any preferential dividend rights
of outstanding shares of preferred stock. Upon the liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to receive
ratably the net assets of the Company available after the payment of all debts
and other liabilities and subject to the prior rights of any outstanding
shares of preferred stock. Holders of Common Stock have no preemptive,
subscription, redemption or conversion rights. The outstanding shares of
Common Stock are, and the shares of Common Stock offered by the Company in the
Offering will be, when issued and paid for, fully paid and nonassessable. The
rights, preferences and privileges of holders of Common Stock are subject to,
and may be adversely affected by, the rights of the holders of shares of any
series of preferred stock which the Company may designate and issue in the
future.
PREFERRED STOCK
The Restated Certificate authorizes the issuance of up to 7,500,000 shares
of preferred stock, $.01 par value per share (the "Preferred Stock"). Under
the terms of the Restated Certificate, the Board is authorized, subject to any
limitations prescribed by law, without stockholder approval, to issue by a
unanimous vote such shares of Preferred Stock in one or more series. Each such
series of Preferred Stock shall have such rights, preferences, privileges and
restrictions, including voting rights, dividend rights, conversion rights,
redemption privileges and liquidation preferences, as shall be determined by
the Board.
The purpose of authorizing the Board to issue Preferred Stock and determine
its rights and preferences is to eliminate delays associated with a
stockholder vote on specific issuances. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult
for a third party to acquire, or of discouraging a third party from acquiring,
a majority of the outstanding voting stock of the Company. The Company has no
present plans to issue any shares of Preferred Stock.
DELAWARE LAW AND CERTAIN PROVISIONS OF THE RESTATED CERTIFICATE AND BYLAWS
The Company is subject to the provisions of Section 203 of the General
Corporation Law of Delaware. Section 203 prohibits a publicly-held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. A "business combination"
includes mergers, asset sales and other transactions resulting in a financial
benefit to the interested stockholder. Subject to certain exceptions, an
"interested stockholder" is a person who, together with affiliates and
associates, owns, or within three years did own, 15% or more of the
corporation's voting stock.
Under the Restated Certificate, any vacancy on the Board, however occurring,
including a vacancy resulting from an enlargement of the Board, may only be
filled by vote of a majority of the directors then in office. The Company's
Bylaws provide that special meetings of the stockholders may only be called by
a Chairman of the Board, the Board or the holders of shares representing at
least forty percent of all the votes enabled to be cast on any issue proposed
to be considered at the special meeting. In addition, the Restated Certificate
and the Company's Bylaws provide that the Bylaws may be amended by the
unanimous consent of the Board.
45
<PAGE>
Under the Company's Bylaws, in order for any matter to be considered "properly
brought" before a meeting, stockholders must comply with certain requirements
regarding advance notice to the Company unless such stockholders hold at least
forty percent of all the votes enabled to be cast on any issue they propose to
be considered at the meeting. Additionally, under the General Corporation Law
of Delaware any action required or permitted to be taken by the stockholders
of the Company at a properly brought meeting may be taken by the written
consent in lieu of a meeting executed by holders having sufficient shares to
approve any action. See "Certain Transactions--Voting Trust."
The Restated Certificate contains certain provisions permitted under the
General Corporation Law of Delaware relating to the liability of directors.
The provisions eliminate a director's liability for monetary damages for a
breach of fiduciary duty, except in certain circumstances involving wrongful
acts, such as the breach of a director's duty of loyalty or acts or omissions
which involve intentional misconduct or a knowing violation of law. Further,
the Restated Certificate contains provisions to indemnify the Company's
directors and officers to the fullest extent permitted by the General
Corporation Law of Delaware. The Company believes that these provisions will
assist the Company in attracting and retaining qualified individuals to serve
as directors.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is American
Stock Transfer & Trust Company.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the Offering, there has been no market for the Common Stock of the
Company. Future sales of substantial amounts of Common Stock in the public
market could adversely affect prevailing market prices.
Upon completion of the Offering (based on shares outstanding at January 31,
1998), the Company will have outstanding an aggregate of 14,923,793 shares of
Common Stock, assuming no exercise of the Underwriters' over-allotment option
and no exercise of outstanding options. The 3,125,000 shares sold in the
Offering will be freely tradeable without restrictions or further registration
under the Securities Act, unless such shares are purchased by an existing
"affiliate" of the Company as that term is defined in Rule 144 under the
Securities Act (an "Affiliate"). The remaining 11,798,793 shares of Common
Stock held by existing stockholders are "restricted securities" as that term
is defined in Rule 144 under the Securities Act ("Restricted Shares").
Restricted Shares may be sold in the public market only if registered or if
they qualify for an exemption from registration, including the exemption
provided by Rule 144 promulgated under the Securities Act, which rule is
summarized below. In addition, the holders of all of the Restricted Shares
have certain demand and piggyback registration rights with respect to such
shares. See "Certain Transactions--Registration Rights Agreement."
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares are aggregated)
who has beneficially owned Restricted Shares for at least one year (including
the holding period of any prior owner except an Affiliate) would be entitled
to sell within any three-month period a number of shares that does not exceed
the greater of (i) one percent of the number of shares of Common Stock then
outstanding (which will equal approximately 149,238 shares immediately after
the Offering); or (ii) the average weekly trading volume of the Common Stock
on the Nasdaq National Market during the four calendar weeks preceding the
filing of a notice on Form 144 with respect to such sale. Sales under Rule 144
are also subject to certain manner of sale provisions, notice requirements and
the availability of current public information about the Company. Under Rule
144(k), a person who is not deemed to have been an Affiliate of the Company at
any time during the 90 days preceding a sale, and who has beneficially owned
the shares proposed to be sold for at least two years (including the holding
period of any prior owner except an Affiliate), is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Accordingly, unless otherwise
restricted, "144(k) shares" may therefore be sold immediately upon the
completion of the Offering.
46
<PAGE>
All existing stockholders of the Company entered, and certain holders of
stock options exercisable within 180 days after the date of this Prospectus
upon the exercise of such options will enter, into agreements (the "Lock-up
Agreements") pursuant to which they agree not to offer, pledge, sell, contract
to sell, sell any option or contract to purchase, purchase any option or
contract to sell, grant any option, right or warrant to purchase, or otherwise
transfer, lend or dispose of, directly or indirectly, any shares of Common
Stock or any securities convertible into or exercisable or exchangeable for
Common Stock or enter into any swap or other arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership of
the Common Stock for a period of 180 days after the date of this Prospectus,
without the prior written consent of Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ"), subject to certain limited exceptions.
Following the Offering, the Company intends to file registration statements
under the Securities Act covering all shares of Common Stock subject to
outstanding options or reserved for issuance under the Company's 1993 Option
Plan, 1997 Stock Plan and 1997 Purchase Plan. See "Management--Stock Plans."
Accordingly, shares registered under such registration statements will,
subject to Rule 144 volume limitations applicable to Affiliates, be available
for sale in the open market following the expiration of the Lock-up
Agreements.
The Company has agreed not to offer, pledge, sell, contract to sell, sell
any option or contract to purchase, purchase any option or contract to sell,
grant any option, right or warrant to purchase, or otherwise transfer, lend or
dispose of, directly or indirectly, any shares of Common Stock or any
securities convertible into or exercisable or exchangeable for Common Stock,
or enter into any swap or similar agreement that transfers, in whole or in
part, the economic risk of ownership of the Common Stock, for a period of 180
days after the date of this Prospectus, without the prior written consent of
DLJ, subject to certain limited exceptions.
47
<PAGE>
UNDERWRITING
Subject to certain conditions contained in the Underwriting Agreement (the
"Underwriting Agreement"), the underwriters named below (the "Underwriters"),
for whom DLJ, NationsBanc Montgomery Securities LLC and William Blair &
Company, L.L.C. are acting as representatives (the "Representatives"), have
severally agreed to purchase from the Company the number of shares of Common
Stock that each Underwriter has agreed to purchase as set forth opposite its
name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation.............. 1,013,625
NationsBanc Montgomery Securities LLC............................ 1,013,625
William Blair & Company, L.L.C. ................................. 357,750
BancAmerica Robertson Stephens................................... 40,000
BT Alex.Brown Incorporated....................................... 40,000
CIBC Oppenheimer Corp. .......................................... 40,000
Goldman, Sachs & Co. ............................................ 40,000
Lazard Freres & Co. LLC.......................................... 40,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated............... 40,000
PaineWebber Incorporated......................................... 40,000
Prudential Securities Incorporated............................... 40,000
SBC Warburg Dillon Read Inc. .................................... 40,000
Smith Barney Inc. ............................................... 40,000
Robert W. Baird & Co. Incorporated............................... 20,000
Blackford Securities Corp. ...................................... 20,000
Fahnestock & Co. Inc. ........................................... 20,000
Janney Montgomery Scott Inc. .................................... 20,000
Johnston, Lemon & Co. Incorporated............................... 20,000
C.L. King & Associates, Inc. .................................... 20,000
McDonald & Company Securities, Inc. ............................. 20,000
Parker/Hunter Incorporated....................................... 20,000
Pennsylvania Merchant Group LTD.................................. 20,000
Ragen Mackenzie Incorporated..................................... 20,000
The Robinson-Humphrey Company, LLC............................... 20,000
Sanders Morris Mundy Inc. ....................................... 20,000
Sands Brothers & Co., Ltd. ...................................... 20,000
Sutro & Co. Incorporated......................................... 20,000
Tucker Anthony Incorporated...................................... 20,000
H.C. Wainwright & Co., Inc. ..................................... 20,000
Wessels, Arnold & Henderson, L.L.C. ............................. 20,000
---------
Total.......................................................... 3,125,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters to purchase and accept delivery of the shares of Common Stock
offered are subject to approval of certain legal matters by counsel and
certain other conditions. If any shares of Common Stock are purchased by the
Underwriters pursuant to the Underwriting Agreement, all such shares (other
than shares covered by the over-allotment option described below) must be
purchased.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute
to payments that the Underwriters may be required to make in respect thereof.
The Representatives have advised the Company that the Underwriters propose
initially to offer the shares of Common Stock to the public at the price set
forth on the cover page of this Prospectus, and to certain dealers
48
<PAGE>
(who may include the Underwriters) at such price less a concession not in
excess of $0.73 per share. The Underwriters may allow, and such dealers may
reallow, discounts not in excess of $0.10 per share to any other Underwriter
and certain other dealers. After the initial public offering, the public
offering price, concession and discount may be changed.
The Company has granted an option to the Underwriters exercisable for 30
days after the date of this Prospectus, to purchase up to an aggregate of
468,750 additional shares of Common Stock at the initial public offering price
set forth on the cover page of this Prospectus, net of underwriting discounts
and commissions. Such option may be exercised at any time until 30 days after
the date of this Prospectus. To the extent that the Representatives exercise
such option, each of the Underwriters will be committed, subject to certain
conditions, to purchase a number of option shares proportionate to such
Underwriter's initial commitment as indicated in the preceding table.
The Company and the existing stockholders of the Company agreed, and certain
holders of stock options exercisable within 180 days after the date of this
Prospectus upon the exercise of such options will agree, subject to certain
exceptions, not to directly or indirectly sell, offer to sell, grant any
option for the sale of or otherwise dispose of any shares of Common Stock or
securities convertible into or exchangeable or exercisable for Common Stock,
without the prior written consent of DLJ, on behalf of the Underwriters, for a
period of 180 days after the date of this Prospectus. See "Shares Eligible for
Future Sale."
Prior to the Offering, there has been no public market for the Common Stock
of the Company. The initial public offering price was determined through
negotiations between the Company and the Representatives. Among the factors
considered in determining the initial public offering price, in addition to
prevailing market conditions, are price-earnings ratios of publicly traded
companies that the Representatives believe to be comparable to the Company,
certain financial information of the Company, the history of, and the
prospects for, the Company and the industry in which it competes, and
assessment of the Company's management, its past and present operations, the
prospects for, and timing of, future revenues of the Company, the present
state of the Company's development, and the above factors in relation to
market values and various valuation measures of other companies engaged in
activities similar to the Company. There can be no assurance that an active
trading market will develop for the Common Stock or that the Common Stock will
trade in the public market subsequent to the Offering at or above the initial
public offering price.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "PCCC."
The Underwriters do not intend to confirm sales of the Common Stock offered
hereby to any accounts over which they exercise discretionary authority.
In connection with the Offering, the Underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the Common Stock.
Specifically, the Underwriters may over-allot the Offering, creating a
syndicate short position. The Underwriters may bid for and purchase shares of
Common Stock in the open market to cover syndicate short positions or to
stabilize the price of the Common Stock. Finally, the underwriting syndicate
may reclaim selling concessions from syndicate members in the Offering, if the
syndicate repurchases previously distributed Common Stock in syndicate
covering transactions, in stabilization transactions or otherwise. Any of
these activities may stabilize or maintain the market price of the Common
Stock above independent market levels. The Underwriters are not required to
engage in these activities, and may discontinue these activities at any time.
Martin C. Murrer, a managing director of DLJ, is a director of the Company.
See "Management-- Executive Officers and Directors."
49
<PAGE>
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Hale and Dorr LLP, Boston, Massachusetts. Certain
legal matters in connection with the Offering will be passed upon for the
Underwriters by Latham & Watkins, New York, New York.
EXPERTS
The financial statements included in this Prospectus and the related
financial statement schedule included elsewhere in the Registration Statement
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their reports appearing herein and elsewhere in the registration statement,
and are included in reliance upon the reports of such firm given upon their
authority as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (which term shall include all
amendments, exhibits, schedules and supplements thereto) on Form S-1 under the
Securities Act with respect to the shares of Common Stock offered hereby. This
Prospectus, which constitutes a part of the Registration Statement, does not
contain all of the information set forth in the Registration Statement,
certain parts of which are omitted in accordance with the rules and
regulations of the Commission, to which Registration Statement reference is
hereby made. Statements made in this Prospectus as to the contents of any
contract, agreement or other document referred to are not necessarily
complete. With respect to each such contract, agreement or other document
filed as an exhibit to the Registration Statement, reference is made to the
exhibit for a more complete description of the matter involved, and each such
statement shall be deemed qualified in its entirety by such reference. The
Registration Statement and the exhibits thereto may be inspected and copied at
prescribed rates at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and at the regional offices of the Commission located at Seven
World Trade Center, 13th Floor, New York, New York 10048 and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. In addition, the
Company is required to file electronic versions to these documents with the
Commission through the Commission's Electronic Data Gathering, Analysis, and
Retrieval (EDGAR) system. The Commission maintains a World Wide Web site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission.
The Company intends to distribute annual reports to its stockholders
containing audited financial statements. The Company also intends to make
available to its stockholders, within 45 days after the end of each fiscal
quarter, reports for the first three quarters of each fiscal year containing
unaudited interim financial information.
50
<PAGE>
PC CONNECTION, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Independent Auditors' Report............................................... F-2
Balance Sheets as of December 31, 1996 and 1997............................ F-3
Statements of Income for the years ended December 31, 1995, 1996 and 1997.. F-4
Statements of Changes in Stockholders' Equity for the years ended December
31, 1995, 1996 and 1997................................................... F-5
Statements of Cash Flows for the years ended December 31, 1995, 1996 and
1997...................................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
PC Connection, Inc.:
We have audited the accompanying balance sheets of PC Connection, Inc. as of
December 31, 1996 and 1997, and the related statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. 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 conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of PC Connection, Inc. as of December 31,
1996 and 1997, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP
Boston, Massachusetts
February 4, 1998
F-2
<PAGE>
PC CONNECTION, INC.
BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
PRO FORMA
1996 1997 1997
ASSETS ------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current Assets:
Cash............................................ $ 162 $ 758 $ 758
Accounts receivable, net........................ 23,163 29,921 29,921
Inventories--merchandise........................ 44,419 63,720 63,720
Prepaid expenses and other current assets....... 1,943 2,580 5,846
------- -------- --------
Total current assets.......................... 69,687 96,979 100,245
Property and equipment, net....................... 7,671 8,463 8,463
Deferred income taxes............................. -- -- 1,234
------- -------- --------
Total......................................... $77,358 $105,442 $109,942
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term borrowings........................... $12,307 $ 28,318 $ 28,318
Current maturities of long-term debt............ 750 1,250 1,250
Dividend payable................................ -- -- 33,000
Amounts payable to stockholders................. -- 1,185 1,185
Accounts payable................................ 36,905 38,174 38,174
Accrued expenses and other liabilities.......... 5,103 9,145 9,145
------- -------- --------
Total current liabilities..................... 55,065 78,072 111,072
Term Loan, less current maturities ............... 4,250 3,250 3,250
------- -------- --------
Total liabilities............................. 59,315 81,322 114,322
------- -------- --------
Commitments and Contingencies (Note 10)
Stockholders' Equity (Deficiency):
Preferred stock:
$.01 par value, 7,500,000 shares authorized,
none issued and outstanding.................. --
Common stock:
Series A Non-Voting, $.01 par value,
22,500,000 shares authorized, 8,849,095
shares issued and outstanding................ 88 88 --
Series B Voting, $.01 par value, 7,500,000
shares authorized, 2,949,698 shares issued
and outstanding.............................. 30 30 --
$.01 par value, 30,000,000 shares authorized,
11,798,793 issued and outstanding............ -- -- 118
Additional paid-in capital (deficiency)......... 3,224 4,097 (4,498)
Retained earnings............................... 14,701 19,905 --
------- -------- --------
Total stockholders' equity (deficiency)....... 18,043 24,120 (4,380)
------- -------- --------
Total......................................... $77,358 $105,442 $109,942
======= ======== ========
</TABLE>
See notes to financial statements.
F-3
<PAGE>
PC CONNECTION, INC.
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1995 1996 1997
-------- ---------- ----------
<S> <C> <C> <C>
Net sales................................... $252,217 $ 333,322 $ 550,575
Cost of sales............................... 211,299 282,117 474,609
-------- ---------- ----------
Gross profit.............................. 40,918 51,205 75,966
Selling, general and administrative
expenses................................... 38,373 43,739 56,596
Additional stockholder/officer
compensation............................... -- 1,259 12,130
-------- ---------- ----------
Income from operations.................... 2,545 6,207 7,240
Interest expense............................ (1,296) (1,269) (1,355)
Other, net.................................. 62 70 (42)
Income taxes................................ (38) (252) (639)
-------- ---------- ----------
Net income................................ $ 1,273 $ 4,756 $ 5,204
======== ========== ==========
Pro forma data:
Historical income before income taxes..... $ 5,843
Pro forma other adjustments............... 12,010
----------
Pro forma income before income taxes ..... 17,853
Pro forma income taxes.................... 6,963
----------
Pro forma net income...................... $ 10,890
==========
Pro forma basic net income per share...... $ 0.79
==========
Pro forma diluted net income per share.... $ 0.76
==========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
PC CONNECTION, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NO PAR
SERIES A SERIES B VALUE ADDITIONAL
COMMON COMMON COMMON PAID-IN RETAINED
STOCK STOCK STOCK CAPITAL EARNINGS TOTAL
-------- -------- ------ ---------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1995................... $-- $-- $ 299 $2,715 $ 8,672 $11,686
Common Stock exchange... 68 22 (299) 209 -- --
Recapitalization and
stock split............ 20 8 -- (28) -- --
Net income.............. -- -- -- -- 1,273 1,273
Compensation under non-
statutory stock option
agreements............. -- -- -- 98 -- 98
---- ---- ----- ------ ------- -------
Balance, December 31,
1995................... 88 30 -- 2,994 9,945 13,057
---- ---- ----- ------ ------- -------
Net income.............. -- -- -- -- 4,756 4,756
Compensation under non-
statutory stock option
agreements............. -- -- -- 230 -- 230
---- ---- ----- ------ ------- -------
Balance, December 31,
1996................... 88 30 -- 3,224 14,701 18,043
---- ---- ----- ------ ------- -------
Net income.............. -- -- -- -- 5,204 5,204
Compensation under non-
statutory stock option
agreements............. -- -- -- 873 -- 873
---- ---- ----- ------ ------- -------
Balance, December 31,
1997................... $88 $30 $ -- $4,097 $19,905 $24,120
==== ==== ===== ====== ======= =======
</TABLE>
See notes to financial statements.
F-5
<PAGE>
PC CONNECTION, INC.
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................ $ 1,273 $ 4,756 $5,204
Adjustments to reconcile net income to net cash
used for operating activities:
Depreciation and amortization..................... 2,795 2,815 3,660
Deferred state income taxes....................... (100) 48 (154)
Compensation under nonstatutory stock option
agreements....................................... 98 230 873
Provision for doubtful accounts................... 1,266 1,389 3,339
Loss (gain) on sales of assets.................... (37) (53) 54
Changes in assets and liabilities:
Accounts receivable............................. (6,236) (7,410) (10,097)
Inventories -- merchandise...................... 7,993 (22,157) (19,301)
Prepaid expenses and other current assets....... (479) 529 (483)
Accounts payable................................ (10,346) 14,610 1,269
Amounts payable to stockholders................. -- -- 1,185
Accrued expenses and other liabilities.......... 979 727 4,042
------- ------- --------
Net cash used for operating activities...... (2,794) (4,516) (10,409)
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............... (945) (3,433) (4,528)
Proceeds from sale of property and equipment...... 40 63 22
------- ------- --------
Net cash used for investing activities...... (905) (3,370) (4,506)
------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings............... 64,882 84,484 178,362
Repayment of short-term borrowings................ (65,482) (77,110) (162,351)
Proceeds from (repayment of) term loan............ 5,000 -- (500)
Repayment of notes payable-- stockholders......... (573) -- --
------- ------- --------
Net cash provided by financing activities... 3,827 7,374 15,511
------- ------- --------
Increase (decrease) in cash....................... 128 (512) 596
Cash, beginning of year........................... 546 674 162
------- ------- --------
Cash, end of year................................. $ 674 $ 162 $758
======= ======= ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid..................................... $ 1,197 $ 1,247 $ 1,334
Income taxes paid................................. 31 96 550
</TABLE>
See notes to financial statements.
F-6
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PC Connection, Inc. (the "Company") is a direct marketer of brand-name
personal computers and related peripherals, software, and networking products
to business, education, government, and consumer end users located primarily in
the United States. The following is a summary of significant accounting
policies.
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.
These estimates and assumptions affect the amounts reported in the accompanying
financial statements. Actual results could differ from those estimates.
Revenue Recognition
Revenue on product sales is recognized at the time of shipment. A reserve for
sales returns is established based upon historical trends.
Inventories--Merchandise
Inventories (all finished goods) consisting of software packages, computer
systems and peripheral equipment, are stated at cost (determined under the
first-in, first-out method) or market, whichever is lower.
Advertising Costs and Revenues
Costs of producing and distributing catalogs are deferred and charged to
expense over the period that each catalog remains the most current selling
vehicle (generally one to two months). Other advertising costs are expensed as
incurred. Vendors have the ability to place advertisements in the catalogs for
which the Company receives advertising allowances and incentives. These
revenues are recognized on the same basis as the catalog costs.
Advertising costs charged to expense were $19,411, $19,878 and $27,859 for
the years ended December 31, 1995, 1996 and 1997, respectively. Advertising
costs of $698 were deferred and are included in prepaid expenses and other
current assets at December 31, 1996. Deferred advertising revenues at December
31, 1997 exceeded deferred advertising costs of $498 and, accordingly, such net
deferred amounts are included in accrued expenses and other liabilities.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided for both
financial and income tax reporting purposes over the estimated useful lives of
the assets ranging from 3 to 7 years. For property acquired
F-7
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
prior to 1996, depreciation was provided using accelerated methods. On January
1, 1996, the Company changed its accounting policy to provide depreciation on
all property and equipment acquired after that date using the straight-line
method. The effect of this change in accounting policy was to increase 1996
income before income taxes by approximately $330. Amortization of leasehold
improvements is provided for by the straight-line method for both financial
and income tax reporting purposes. For financial reporting purposes, leasehold
improvements are amortized over the terms of the related leases or their
useful lives, whichever is shorter, whereas for income tax reporting purposes,
they are amortized over the applicable tax lives. The Company periodically
evaluates the carrying value of property and equipment based upon current and
anticipated undiscounted cash flows, and recognizes an impairment when it is
probable that such estimated future net income and/or cash flows will be less
than the asset carrying value.
Tax Status and Income Taxes
The stockholders of the Company have elected S Corporation tax status. As a
result of this election, the federal taxable income of the Company is reported
in the individual federal income tax returns of the stockholders, and no
provision for federal income taxes is included in the accompanying financial
statements.
The Company and certain of its affiliates (entities under common control)
file their New Hampshire business profits tax returns on a unitary basis. Each
company calculates its tax provision on a separate company basis as if it
filed a separate tax return.
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future,
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount that is
more likely than not to be realized. Income taxes comprise the tax payable or
refundable for the period plus or minus the change during the period in
deferred tax assets and liabilities.
Effective with the closing of the Company's proposed initial public offering
(the "Offering," see Note 12), the Company's S Corporation election will
automatically be terminated, and the Company will be subject to federal and
state income taxes as a C Corporation from that date forward.
Additional Stockholder/Officer Compensation
Additional stockholder/officer compensation represents amounts accrued or
distributed in excess of aggregate annual base salaries approved by the Board
of Directors and generally represents Company-related federal income tax
obligations payable by the stockholders.
Fair Value of Financial Instruments
The fair value of the Company's financial instruments, consisting of
accounts receivable, accounts payable and bank borrowings, approximates
carrying value.
Concentration of Credit Risk
Concentrations of credit risk with respect to trade account receivables are
limited due to the large number of customers comprising the Company's customer
base. Ongoing credit evaluations of customers' financial condition are
performed.
Stock-Based Compensation
Compensation expense associated with awards of stock or options to employees
is measured using the intrinsic value method in accordance with APB Opinion
No. 25. The Company's Board of Directors estimates the fair value of the
Company's stock using market valuations of comparable publicly traded
companies, among other factors.
F-8
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Recent Pronouncements of the Financial Accounting Standards Board
Recent pronouncements of the Financial Accounting Standards Board ("FASB"),
which are not required to be adopted at December 31, 1997, include the
following Statements of Financial Accounting Standards ("SFAS"):
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income (all changes in equity during
a period except those resulting from investments by and distributions to
owners) and its components in the financial statements. This new standard,
which will be effective for the Company for the year ending December 31,
1998, is not currently anticipated to have a significant impact on the
Company's financial statement disclosures based on the current financial
structure and operations of the Company.
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," which will be effective for the Company for the year ending
December 31, 1998, establishes standards for reporting information about
operating segments in the annual financial statements, selected information
about operating segments in interim financial reports and disclosures about
products and services, geographic areas and major customers. This new
standard may require the Company to report financial information on the
basis that is used internally for evaluating segment performance and
deciding how to allocate resources to segments, which may result in more
detailed information in the notes to the Company's financial statements
than is currently required and provided. The Company has not yet determined
the effect, if any, of implementing SFAS No. 131 on its reporting of
financial information.
Reclassifications
Certain amounts in the 1995 and 1996 financial statements have been
reclassified to conform to the 1997 presentation.
2. PRO FORMA INFORMATION
Pro Forma Income Statement Data (unaudited)
The following pro forma adjustments have been made to the historical results
of operations to make the pro forma presentation comparable to what would have
been reported had the Company operated as a C Corporation:
(i) Elimination of stockholder/officer compensation expense in excess of
aggregate annual base salaries of $600 to be in effect during 1998 in
accordance with employment agreements; and
(ii) Computation of income tax expense assuming an effective tax rate of
39% (see Note 8) and after adjusting stockholder/officer compensation
expense described in (i) above.
The Company has adopted the provisions of SFAS No. 128, "Earnings Per Share"
for purposes of presenting pro forma basic and diluted net income per share.
The denominator used to determine basic net income per share includes the
weighted average common shares outstanding for the year and the number of
shares required to pay the S Corporation Dividend (assuming a price per share
of $16.00) (which if made at December 31, 1997 would have approximated
$33,000). The denominator used to determine diluted net income per share
includes the shares used in the calculation of basic net income per share plus
dilutive weighted average options outstanding in 1997.
F-9
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The following table presents a reconciliation of the numerators and
denominators of pro forma basic and diluted net income per share:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ --------------- ----------
<S> <C> <C> <C>
Pro forma net income............. $ 10,890
Weighted average shares
outstanding..................... 11,798,793
Shares required to pay
stockholder dividend............ 2,062,500
------------ ---------------
Pro forma basic net income per
share........................... 10,890 13,861,293 $ .79
=========
Effect of dilutive securities.... 382,910
------------ ---------------
Pro forma diluted earnings per
share........................... $10,890 14,244,203 $ .76
============ =============== =========
</TABLE>
Pro Forma Balance Sheet (unaudited)
The following pro forma adjustments have been made to the historical balance
sheet to give effect to the Reincorporation and to make the presentation
comparable to what would have been reported had the Company operated as a C
Corporation:
(i) Conversion of the issued and outstanding shares of Series A Non-
Voting Common Stock, $.01 par value per share, and Series B Voting Common
Stock, $.01 par value per share, into Common Stock, $.01 par value per
share, on a one-for-one basis.
(ii) Declaration of a stockholder dividend of approximately $33,000
representing cumulative undistributed S Corporation earnings through
December 31, 1997 (see Note 12); and
(iii) Establishment of an additional net deferred income tax asset of
approximately $4,500 resulting from the termination of the Company's S
Corporation status.
3. ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------- -------
<S> <C> <C>
Trade...................................................... $16,125 $28,885
Co-op advertising.......................................... 3,880 2,880
Vendor returns, rebates and other.......................... 5,309 3,516
------- -------
Total.................................................. 25,314 35,281
Less allowances for:
Sales returns............................................ (867) (2,701)
Doubtful accounts........................................ (1,284) (2,659)
------- -------
Accounts receivable, net................................... $23,163 $29,921
======= =======
</TABLE>
F-10
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
-------- --------
<S> <C> <C>
Leasehold improvements................................... $ 4,093 $ 3,857
Furniture and equipment.................................. 18,087 20,595
Software licenses........................................ 1,060 1,413
Automobiles.............................................. 278 175
-------- --------
Total.................................................. 23,518 26,040
Less accumulated depreciation and amortization........... (15,847) (17,577)
-------- --------
Property and equipment, net.............................. $ 7,671 $ 8,463
======== ========
</TABLE>
5. BANK BORROWINGS
At December 31, 1997, the Company had a revolving credit agreement with a
bank providing for short-term borrowings equal to the lesser of $45,000 or an
amount determined by a formula based on accounts receivable and inventory
balances, and a term loan for $5,000, due in quarterly installments of $250
through March 31, 2002. Short-term borrowings were collateralized by all
accounts receivable and inventories (other than inventories pledged to secure
trade credit arrangements) and bear interest at either the prime rate (8.5% at
December 31, 1997) or the adjusted Libor rate plus 2.0%. The term loan is
collateralized by all other assets of the Company and bears interest at either
the prime rate (8.5% at December 31, 1997) or the Bank's Cost of Funds Rate
plus 2.5%. The revolving credit agreement includes various customary financial
and operating covenants, including working capital requirements, debt-to-net-
worth ratios, minimum net income requirements and restrictions on the payment
of dividends, except for distributions in respect of income taxes, none of
which, in the opinion of management, significantly restricts the Company's
operations.
Certain information with respect to short-term borrowings was as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE MAXIMUM AMOUNT AVERAGE AMOUNT
INTEREST RATE OUTSTANDING OUTSTANDING
---------------- -------------- --------------
<S> <C> <C> <C>
Year ended December 31,
1995........................ 10.0% $16,000 $9,613
1996........................ 9.0% 23,527 7,921
1997........................ 8.6% 31,890 9,458
</TABLE>
6. TRADE CREDIT ARRANGEMENTS
At December 31, 1996 and 1997, the Company had security agreements with two
financial institutions to facilitate the purchase of inventory from various
suppliers under certain terms and conditions. The agreements allow a
collateralized position in inventory financed by the financial institutions up
to an aggregate amount of $14,900 in 1996 and $24,900 in 1997 (with seasonal
increases to $22,350 from October 1, 1996 to January 31, 1997 and $37,350 from
October 22, 1997 through January 31, 1998). The cost of such financing under
these agreements is borne by the suppliers. At December 31, 1996 and 1997,
accounts payable included $10,235 and $5,394, respectively owed to these
financial institutions.
7. STOCKHOLDERS' EQUITY
Common Stock Exchange
On March 28, 1995, the Company amended its Articles of Incorporation to
change the par value of its stock to $.01 per share. Additionally, the Company
reclassified the 10,000,000 authorized shares of common stock to
F-11
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7,500,000 shares of Series A Non-Voting Common Stock, par value $.01 per
share, and 2,500,000 shares of Series B Voting Common Stock, par value $.01
per share, with one vote per share.
Recapitalization and Stock Split
On February 4, 1998, the Company amended its Articles of Incorporation to
increase the authorized shares of the Company's Series A Non-Voting Common
Stock, $.01 par value per share, and Series B Voting Common Stock, $.01 par
value per share to 22,500,000 and 7,500,000 shares, respectively. The Company
also, through a 1.310977-for-one stock split, increased the total number of
Series A Non-Voting and Series B Voting shares issued and outstanding to
8,849,095 shares and 2,949,698 shares, respectively. The effect of this
recapitalization and stock split has been reflected in the Company's financial
statements and related notes thereto for all periods presented.
Prior to consummation of the Offering (see Note 12), the Company expects to
reincorporate in Delaware.
1993 Incentive and Non-Statutory Stock Option Plan
In December 1993, the Board of Directors adopted and the stockholders
approved the 1993 Incentive and Non-Statutory Stock Option Plan (the "Plan").
Under the terms of the Plan, the Company is authorized to make awards of
restricted stock and to grant incentive and non-statutory options to employees
of, and consultants and advisors to, the Company to purchase shares of the
Company's common stock. A total of 1,124,163 shares of the Company's common
stock may be issued upon exercise of options granted or awards made under the
Plan. Options vest over varying periods up to four years and are restricted as
to exercise except upon the occurrence of certain events, including an initial
public offering of the Company's common stock (see Note 12). All restrictions
on options expire no more than seven years from the date of grant.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"). Accordingly,
compensation expense for options awarded under the Plan in 1995, 1996 and
1997, has been recognized using the intrinsic value method.
Information regarding the Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
OPTION EXERCISE AVERAGE
SHARES PRICE FAIR VALUE
--------- -------- ----------
<S> <C> <C> <C>
Outstanding, January 1, 1995.................. 734,147 $2.18
Granted..................................... 314,634 3.04 $1.81
Forfeited................................... (393,292) 2.42
---------
Outstanding, December 31, 1995................ 655,489 2.45
Granted..................................... 117,988 1.44 2.86
Forfeited................................... (183,537) 3.59
---------
Outstanding, December 31, 1996................ 589,940 1.89
Granted..................................... 504,070 4.97 4.22
---------
Outstanding, December 31, 1997................ 1,094,010 3.31
=========
</TABLE>
F-12
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1997, no options were exercisable under the Plan. The
following table summarizes the status of outstanding stock options as of
December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
OPTIONS REMAINING
EXERCISE PRICE OUTSTANDING LIFE (YEARS)
-------------- ----------- ------------
<S> <C> <C>
$0.76 560,443 6.7
3.81 176,982 8.9
5.72 310,045 8.8
16.00 46,540 9.9
</TABLE>
The fair value of options at the date of grant was estimated using the
minimum value method. Risk-free interest rates and expected lives of option
grants used in applying this pricing model were 6% and seven years,
respectively, in 1995, 1996 and 1997, respectively.
The minimum value pricing method was designed to value stock options of non-
public companies;, accordingly, the minimum value method assumes zero
volatility. The options granted to employees are not tradable and have
contractual lives of up to ten years. Management believes that the assumptions
used and the model applied to value the awards yields a reasonable estimate of
the fair value of the grants made under the circumstances, given the
alternatives available under SFAS No. 123.
Aggregate compensation expense, related to options granted at exercise
prices less than fair value on the dates of grant, is being charged to expense
ratably over seven years from the dates of grant (see Note 12). Compensation
expense charged to operations using the intrinsic value method totaled $98,
$230, and $873 in 1995, 1996, and 1997, respectively (net of expense reversals
related to forfeitures by terminated employees aggregating $139 and $49 in
1995 and 1996, respectively). Had the Company recorded compensation expense,
using the minimum value method under SFAS No. 123, it would have reported
additional compensation expense of $5, $6 and $66 in 1995, 1996 and 1997,
respectively. Net income would have been $1,268, $4,750 and $5,138 for 1995,
1996 and 1997, respectively. The unaudited pro forma basic and diluted net
income per share in 1997 would have been $0.78, and $0.76, respectively. These
pro forma compensation disclosures would not necessarily be indicative of the
effects on reported net income for future years if the Company were a public
entity.
8. INCOME TAXES
The provision for income taxes was $38, $252 and $639 for the years ended
December 31, 1995, 1996 and 1997, respectively. These provisions are based on
the state income tax obligations of the Company as an S Corporation. Certain
items of income are recognized in different years for financial reporting and
income tax purposes, and the Company has recorded deferred tax assets for the
state income tax effect of these differences. Deferred tax assets were $221
and $375 at December 31, 1996 and 1997, respectively, and were included in
prepaid expenses and other current assets.
F-13
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Effective with the closing of the Company's proposed initial public offering
(see Note 12), the Company's S Corporation election will automatically be
terminated and the Company will then account for income taxes as a C
Corporation. The 1997 provision (benefit) for income taxes on an unaudited pro
forma basis consisted of the following:
<TABLE>
<S> <C>
Currently payable:
Federal............................................................... $9,214
State................................................................. 793
------
10,007
------
Deferred:
Federal............................................................... (2,890)
State................................................................. (154)
------
(3,044)
------
$6,963
======
</TABLE>
The components of the unaudited pro forma net deferred tax asset at December
31, 1997 are as follows:
<TABLE>
<S> <C>
Provisions for doubtful accounts....................................... $ 2,003
Inventory costs capitalized for tax purposes........................... 548
Inventory and sales returns reserves................................... 1,032
Accumulated depreciation............................................... 664
Compensation under non-statutory stock option agreements............... 570
Deductible expenses, primarily employee-benefit related................ 733
Accrued additional stockholder/officer compensation.................... 462
Other liabilities...................................................... (1,137)
-------
Deferred tax asset--net................................................ $ 4,875
=======
</TABLE>
The reconciliation of the Company's 1997 unaudited pro forma income tax
provision to the statutory federal tax rate is as follows:
<TABLE>
<S> <C>
Statutory tax rate........................................................ 35.0%
State income taxes, net of federal benefit................................ 2.6
Nondeductible expenses.................................................... 0.2
Other--net................................................................ 1.2
----
Effective income tax rate................................................. 39.0%
====
</TABLE>
As of December 31, 1997, the Company had no net operating loss carry
forwards or other tax benefits available to offset future taxable income.
9. EMPLOYEE BENEFIT PLANS
The Company has a contributory profit-sharing plan covering all qualified
employees. No contributions to the profit-sharing plan were made in 1995, 1996
or 1997 by the Company. The Company made matching contributions to an employee
savings plan of approximately $102, $177, and $171 in 1995, 1996 and 1997,
respectively.
F-14
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
10. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases certain office facilities from its principal stockholders
under 20-year noncancelable operating leases. The lease agreement for one
facility requires the Company to pay all real estate taxes and insurance
premiums related thereto. The Company also leases several other buildings from
the its principal stockholders on a month-to-month basis.
In addition, the Company leases office and warehouse facilities from
unrelated parties with remaining terms of one to four years.
Future aggregate minimum annual lease payments under these leases at
December 31, 1997 (excluding the lease entered into in November 1997 referred
to below) are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31 RELATED PARTIES OTHERS TOTAL
----------------------- --------------- ------ ------
<S> <C> <C> <C>
1998.......................................... $ 251 $ 841 $1,092
1999.......................................... 251 451 702
2000.......................................... 251 451 702
2001.......................................... 251 -- 251
2002.......................................... 221 -- 221
2003 and thereafter .......................... 1,022 -- 1,022
------ ------ ------
$2,247 $1,743 $3,990
====== ====== ======
</TABLE>
Total rent expense aggregated $1,072, $1,057 and $1,398 for the years ended
December 31, 1995, 1996 and 1997, respectively, under the terms of the leases
described above. Such amounts included $298, $111 (net of a $200 lease
termination payment received) and $311 in 1995, 1996 and 1997, respectively,
paid to related parties.
In November 1997, the Company entered into a fifteen-year lease for a new
corporate headquarters with an affiliated company related to the Company
through common ownership. The Company expects to occupy the facility in the
summer of 1998 upon the anticipated completion of construction, and the lease
payments will commence upon the date of occupancy. Annual lease payments under
the terms of the lease, as amended on December 29, 1997, will be approximately
$823 for the first five years of the lease, increasing to $926 for years six
through ten and $1,029 for years eleven through fifteen. The lease requires
the Company to pay its proportionate share of real estate taxes and common
area maintenance charges as additional rent and also to pay insurance premiums
for the leased property. The Company has the option to renew the lease for two
additional terms of five years each.
Contingencies
The Company is subject to various legal proceedings and claims which have
arisen during the ordinary course of business. In the opinion of management,
the outcome of such matters is not expected to have a material effect on the
Company's financial position, results of operations and cash flows.
F-15
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
11. OTHER RELATED-PARTY TRANSACTIONS
Other related-party transactions include the transactions summarized below.
Related parties consist primarily of affiliated companies related to the
Company through common ownership.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
Revenue:
Provision of management and other services to
various affiliated companies...................... $ 78 $ -- $--
Sales of various products.......................... 48 37 38
Sales of property and equipment:
Net book value................................... (30) -- (14)
Proceeds......................................... 33 19 16
Costs:
Purchase of services from affiliated companies..... 80 763 1,280
Interest paid to stockholders...................... 4 -- --
</TABLE>
12. SUBSEQUENT EVENTS
Initial Public Offering (unaudited)
The Company is pursuing an initial public offering of its Common Stock. The
Company plans to use a portion of the net proceeds of the Offering to repay
certain of the Company's bank borrowings under its revolving credit agreement
and term note payable (see Note 5) and to make a distribution to current
stockholders in an amount equal to the Company's cumulative undistributed tax
basis S Corporation retained earnings at the closing date of the Offering. Had
the closing date of the Offering occurred on December 31, 1997, the dividend
payable to the stockholders would have been approximately $33,000. Such
dividend payable has been reflected in the pro forma balance sheet as of
December 31, 1997.
Reincorporation of the Company (unaudited)
The Company, currently incorporated in New Hampshire, expects to
reincorporate in Delaware prior to the consummation of the Offering (the
"Reincorporation"). Pursuant to the Reincorporation, the Company will convert
all of the issued and outstanding shares of Series A Non-Voting Common Stock,
$.01 par value per share, and Series B Voting Common Stock, $.01 par value per
share, of the New Hampshire corporation into 11,798,793 shares of Common
Stock, $.01 par value, of the Delaware corporation on a one-for-one basis.
Preferred Stock (unaudited)
The Amended and Restated Certificate of Incorporation of the Delaware
corporation (the "Restated Certificate") authorizes the issuance of up to
7,500,000 shares of preferred stock, $.01 par value per share (the "Preferred
Stock"). Under the terms of the Restated Certificate, the Board is authorized,
subject to any limitations prescribed by law, without stockholder approval, to
issue by a unanimous vote such shares of Preferred Stock in one or more
series. Each such series of Preferred Stock shall have such rights,
preferences, privileges and restrictions, including voting rights, dividend
rights, conversion rights, redemption privileges and liquidation preferences,
as shall be determined by the Board.
1997 Employee Stock Purchase Plan (unaudited)
On November 21, 1997, the Board of Directors adopted and the stockholders
approved the 1997 Employee Stock Purchase Plan ("the Purchase Plan"), which
becomes effective on the closing of the Offering. The
F-16
<PAGE>
PC CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Purchase Plan authorizes the issuance of Common Stock to participating
employees. Under the terms of the Purchase Plan, the option price is an amount
equal to 85% of the fair market value per share of the Common Stock on either
the first day or the last day of the offering period, whichever is lower. An
aggregate of 225,000 shares of Common Stock has been reserved for issuance
under the Purchase Plan.
1997 Stock Incentive Plan (unaudited)
On November 21, 1997, the Board of Directors adopted and the stockholders
approved the 1997 Stock Incentive Plan, which becomes effective on the closing
of the Offering and provides for the grant of incentive stock options, non-
statutory stock options, stock appreciation rights, performance shares and
awards of restricted stock and unrestricted stock. An aggregate of 800,000
shares of Common Stock has been reserved for issuance under the 1997 Stock
Incentive Plan.
Termination of S Corporation Election (unaudited)
Effective with the consummation of the Offering, the Company's S Corporation
election will automatically terminate and the Company expects to record a tax
benefit of approximately $4,500 (estimated at December 31, 1997) relating to
the establishment of additional net deferred tax assets for future tax
deductions resulting from the termination of the S Corporation election.
Compensation Under Non-Statutory Stock Option Agreements
Upon consummation of the Offering, certain restrictions as to the exercise
of options granted under the Company's 1993 Incentive and Non-Statutory Stock
Option Plan will expire. The Company is currently recording compensation
expense for certain options granted at prices less than their fair value
ratably over seven years from the dates granted, since such options are not
exercisable except upon occurrence of certain events (see Note 7). Effective
with the consummation of the Offering, the Company will record an additional
one-time charge for stock-option compensation expense of approximately $870,
representing the cumulative effect of recording compensation expense relating
to these options over their vesting periods.
* * * * *
F-17
<PAGE>
INSIDE BACK COVER
- -----------------
[ACROSS THE TOP OF THE PAGE:
PICTURE OF THE RACCOON CHARACTER(R) WITH AWARDS AROUND ITS NECK TO THE
LEFT AND THE TEXT "PC CONNECTION YOUR SOURCE FOR COMPUTERS, SOFTWARE
AND PERIPHERALS SINCE 1982"]
[AT LEFT CENTER OF PAGE:
CAPTION ABOVE PICTURE: DISTRIBUTION CENTER
PICTURE OF INDIVIDUALS PACKING PRODUCTS TO FILL ORDERS AT THE
DISTRIBUTION CENTER.
CAPTION BELOW PICTURE: CUSTOMERS CAN PLACE THEIR ORDERS FOR PRODUCTS
UNTIL 2:45 A.M. ET AND STILL GET OVERNIGHT DELIVERY.]
[AT MIDDLE CENTER OF PAGE:
CAPTION ABOVE PICTURE: SALES TEAM
PICTURE OF SALES PEOPLE AT THE CALL CENTER TAKING CALLS.
CAPTION BELOW PICTURE: PC CONNECTION SERVICES CUSTOMERS FROM ITS CALL
CENTERS LOCATED IN KEENE, HUDSON AND MILFORD, NEW HAMPSHIRE.]
[AT RIGHT CENTER OF PAGE:
CAPTION ABOVE PICTURE: DATA CENTER
PICTURE OF COMPANY MANAGEMENT INFORMATION COMPUTER SYSTEMS.
CAPTION BELOW PICTURE: THE COMPANY'S MARKETING AND SALES ACTIVITIES ARE
SUPPORTED BY MULTIPLE IBM AS/400 AND RS6000 COMPUTERS, PLUS WINDOWS NT-
BASED SERVERS.]
[ACROSS THE BOTTOM OF THE PAGE:
15 YEARS OF MAIL-ORDER EXPERIENCE]
[UNDER CAPTION LEFT COLUMN LISTS THE FOLLOWING:
1982 PC CONNECTION FOUNDED EXCLUSIVELY
TO SERVE THE IBM PC CUSTOMER.
1984 MACCONNECTION DIVISION FOUNDED
EXCLUSIVELY TO SERVE THE APPLE
MACINTOSH CUSTOMER.
1987 EVERYTHING OVERNIGHT.(R) CUSTOMER
ORDERS PLACED UP TO 8 P.M. ET ARE
DELIVERED THE NEXT DAY.
1989 30-DAY MONEY-BACK GUARANTEES
OFFERED ON MOST PRODUCT LINES.]
[RIGHT COLUMN LISTS THE FOLLOWING:
1990 EVERYTHING OVERNIGHT(R) SERVICE
EXTENDED TO 2:45 A.M. ET, INCLUDING
DELIVERY ON SATURDAY.
1991 ONE-MINUTE MAIL ORDER.(R) NEW CALLER
ID APPLICATIONS SPEED ORDER TAKING.
ORDERS PLACED ON WEEKENDS ARE DELIVERED
MONDAY MORNING.
1993 COMPUTERS CUSTOM-CONFIGURED AT NO
ADDITIONAL CHARGE; ORDERS PLACED BY
MIDNIGHT ARE DELIVERED THE NEXT DAY.
1996 PC CONNECTION ONLINE SUPERSTORE DEBUTS
ON THE WEB.]
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALES PERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS, AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO BUY, THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAW-
FUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS
NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICA-
TION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPEC-
TUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 14
Dividend Policy.......................................................... 14
Capitalization........................................................... 15
Dilution................................................................. 16
Selected Financial and Operating Data.................................... 17
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 19
Business................................................................. 26
Management............................................................... 35
Certain Transactions..................................................... 41
Principal Stockholders................................................... 44
Description of Capital Stock............................................. 45
Shares Eligible for Future Sale.......................................... 46
Underwriting............................................................. 48
Legal Matters............................................................ 50
Experts.................................................................. 50
Additional Information................................................... 50
Index to Financial Statements............................................ F-1
</TABLE>
------------
UNTIL MARCH 28, 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
3,125,000 SHARES
[LOGO OF PC CONNECTION, INC. APPEARS HERE]
COMMON STOCK
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATIONSBANC MONTGOMERY
SECURITIES LLC
WILLIAM BLAIR & COMPANY
MARCH 3, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
----------------
PROSPECTUS
----------------
