UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO _______________
COMMISSION FILE NUMBER 0-23827
PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 02-0497006
-------- ----------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
730 MILFORD ROAD,
MERRIMACK, NEW HAMPSHIRE 03054
------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (603) 423-2000
--------------
Indicate by check mark (X) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the issuer's Common Stock, $.01 par value,
as of July 31, 1999 was 15,649,265.
<PAGE>
PC CONNECTION, INC. AND SUBSIDIARY
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C>
PART I FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1 Financial Statements:
Consolidated Balance Sheets - June 30, 1999
and December 31, 1998.......................................1
Consolidated Statements of Income -
Three months ended June 30, 1999 and 1998;
Six months ended June 30, 1999 and 1998.....................2
Consolidated Statement of Changes in Stockholders' Equity - Six
months ended June 30, 1999..................................3
Consolidated Statements of Cash Flows - Six
months ended June 30, 1999 and 1998 ........................4
Notes to Financial Statements.................................5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................9
Item 3 Qualitative and Quantitative Disclosures About Market Risk...16
PART II OTHER INFORMATION
-----------------
Item 1 Legal Proceedings............................................17
Item 2 Changes in Securities and Use of Proceeds....................17
Item 3 Defaults Upon Senior Securities..............................17
Item 4 Submission of Matters to a Vote of Security Holders..........17
Item 5 Other Information............................................17
Item 6 Exhibits and Reports on Form 8-K.............................17
SIGNATURES...................................................18
----------
</TABLE>
<PAGE>
PC CONNECTION, INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, December 31,
1999 1998
-------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 3,235 $11,910
Accounts receivable, net 73,302 58,890
Inventories-merchandise 62,837 63,425
Deferred income taxes 2,038 3,181
Prepaid expenses and other current assets 3,656 4,115
------- ------
TOTAL CURRENT ASSETS 145,068 141,521
Goodwill 9,755 -
Deferred income taxes 330 314
Property and equipment, net 23,786 22,675
------- ------
TOTAL ASSETS $178,939 $164,510
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of capital lease obligation
to affiliate $ 169 $ 123
Notes payable, current maturities 1,000 -
Accounts payable 78,319 77,561
Accrued expenses and other liabilities 11,140 10,069
------- ------
TOTAL CURRENT LIABILITIES 90,628 87,753
Notes payable, less current maturities 2,000 -
Capital lease obligation to affiliate 7,016 7,081
------- ------
TOTAL LIABILITIES 99,644 94,834
------- ------
Stockholders' Equity:
Common stock 156 156
Additional paid-in capital 57,342 56,812
Retained earnings 21,797 12,708
------- ------
TOTAL STOCKHOLDERS' EQUITY 79,295 69,676
------- ------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $178,939 $164,510
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
-1-
PC CONNECTION INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
----------------- ---------------
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net sales $231,833 $174,349 $456,812 $342,992
Cost of sales 204,034 151,768 401,947 298,462
------- ------- -------- -------
GROSS PROFIT 27,799 22,581 54,865 44,530
Selling, general and
administrative expenses 20,040 16,042 39,803 32,900
Additional stockholder/
officer compensation - - - 2,354
------- -------- ------- --------
INCOME FROM OPERATIONS 7,759 6,539 15,062 9,276
Interest expense (276) (51) (542) (257)
Other, net 47 213 141 299
Income tax benefit (provision) (2,862) (2,613) (5,572) 1,175
------- ------- -------- -------
NET INCOME $ 4,668 $ 4,088 $ 9,089 $10,493
======= ======= ======== =======
Weighted average shares outstanding:
Basic 15,627 15,414 15,625
======= ======= ========
Diluted 16,061 15,938 16,067
======= ======= ========
Earnings per share:
Basic $ 0.30 $ .27 $ .58
======= ======= ========
Diluted $ 0.29 $ .26 $ .57
======= ======= ========
Pro forma data:
Historical income before income taxes $ 9,318
Pro forma adjustment - stockholder/officer
compensation in excess of aggregate base salaries 2,354
--------
Pro forma income before income taxes 11,672
Pro forma income taxes (4,552)
--------
Pro forma net income $ 7,120
========
Pro forma weighted average shares outstanding:
Basic 14,829
========
Diluted 15,371
========
Pro forma earnings per share:
Basic $ .48
========
Diluted $ .46
========
</TABLE>
See accompanying notes to consolidated financial statements.
-2-
<PAGE>
PC CONNECTION INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED
------------
SHARES AMOUNT PAID IN CAPITAL EARNINGS TOTAL
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1998 15,605 $ 156 $56,812 $12,708 $69,676
Exercise of stock options,
including income tax
benefits 25 - 266 - 266
Issuance of stock under
employee stock purchase plan 19 - 198 - 198
Compensation under nonstatutory
stock option agreements - - 66 - 66
Net income - - - 9,089 9,089
------ ------ ------- ------- ------
BALANCE, JUNE 30, 1999 15,649 $ 156 $57,342 $21,797 $79,295
======= ====== ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> -3-
PC CONNECTION INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1999 1998
------ -----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $9,089 $10,493
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,367 1,361
Deferred income tax provision (benefit) 1,277 (5,025)
Compensation under nonstatutory stock
option agreements 66 1,172
Provision for doubtful accounts 2,896 1,403
Loss on disposal of fixed assets 24 74
Changes in assets and liabilities:
Accounts receivable (12,767) (5,979)
Inventories 1,206 4,835
Prepaid expenses and other current assets 912 (1,118)
Accounts payable (7,283) 26,975
Amounts payable to stockholders - (1,185)
Accrued expenses and other liabilities (108) 1,506
------ ------
Net cash (used for) provided by operating activities (2,321) 34,512
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (3,415) (3,637)
Proceeds from sale of property and equipment 3 -
Payment for purchase of ComTeq, net of cash acquired (3,198) -
------- ------
Net cash used for investing activities (6,610) (3,637)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 246,251 20,796
Repayment of short-term borrowings (246,251) (49,174)
Repayment of term loan - (4,500)
Repayment of capital lease obligations (58) -
Issuance of stock upon exercise of nonstatutory
stock options 116 27
Issuance of stock under Employee Stock Purchase Plan 198 -
Net proceeds from initial public offering - 57,253
Payment of dividend - (33,037)
------ -------
Net cash provided by (used for) financing activities 256 (8,635)
------ -------
(Decrease) increase in cash and cash equivalents (8,675) 22,240
Cash and cash equivalents, beginning of period 11,910 758
------ -------
Cash and cash equivalents, end of period $3,235 $22,998
====== =======
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 273 $ 392
Income taxes paid 2,414 2,679
NON-CASH TRANSACTIONS:
Issuance of notes payable in connection
with acquisition of a subsidiary $ 3,000 $ -
</TABLE>
See accompanying notes to consolidated financial statements
-4-
<PAGE>
PC CONNECTION INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
- ------------------------------
The accompanying consolidated financial statements of PC Connection, Inc. and
Subsidiary ("PCC" or the "Company") have been prepared in accordance with
generally accepted accounting principles. Such principles were applied on a
basis consistent with those of the financial statements contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998 (the
"10-K Report") filed with the Securities and Exchange Commission ("SEC"). The
accompanying consolidated financial statements should be read in conjunction
with the financial statements contained in the Company's 10-K Report. In the
opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation. The operating results for the
three and six months ended June 30, 1999 may not be indicative of the results
expected for any succeeding quarter or the entire year ending December 31, 1999.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements. Actual results may
differ from those estimates.
Certain amounts in the prior year financial statements have been reclassified to
conform to the current year presentation.
NOTE 2 - CASH AND CASH EQUIVALENTS
- ----------------------------------
The Company considers all highly liquid short-term investments with original
maturities of 90 days or less to be cash equivalents.
NOTE 3 - INITIAL PUBLIC OFFERING
- --------------------------------
On March 6, 1998, the Company completed its initial public offering of 3,593,750
shares of Common Stock ("the Offering") (including 468,750 shares issued upon
the exercise of an underwriters' overallotment option) at a price of $17.50 per
share, raising $57.3 million in net proceeds. The Company used the net proceeds
from the Offering to repay bank indebtedness ($12.9 million) and to pay a
dividend to stockholders of record as of February 27, 1998 ($33.0 million) equal
to substantially all previously taxed, but undistributed, S Corporation earnings
of the Company. The remaining net proceeds ($11.4 million) have been used for
general corporate purposes.
NOTE 4 - PRO FORMA INCOME STATEMENT DATA
- -----------------------------------------
The following pro forma adjustments have been made to the historical results of
operations for the six months ended June 30, 1998 to make the pro forma
presentation comparable to what would have been reported had the Company
operated as a C Corporation for that period:
1. Elimination of stockholder/officer compensation in excess of aggregate
established 1998 quarterly base salaries ($150,000) for the period prior to
March 6, 1998. These amounts generally represented Company-related S
Corporation tax obligations payable by the stockholder/officers for periods
prior to March 6, 1998.
2. Elimination of the historical income tax benefit for the period prior to
March 6, 1998 (including elimination of the $4.2 million income tax benefit
related to the establishment of additional deferred tax assets for future tax
deductions resulting from the termination of the Company's Subchapter S
Corporation status) and establishment of a provision for federal and state
income taxes that would have been payable by the Company if taxed under
Subchapter C of the Code, assuming an effective tax rate of 39% for the
quarter ended March 31, 1998 after an adjustment for stockholder/officer
compensation described in No. 1 above.
-5-
<PAGE>
NOTE 5 - EARNINGS PER SHARE
- ---------------------------
Basic earnings per common share is computed using the weighted average number of
shares outstanding. Diluted earnings per common share is computed using the
weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding options to purchase common stock. The
denominator used to determine pro forma basic earnings per share for the six
months ended June 30, 1998 includes the weighted average shares required to pay
the S Corporation dividend, assuming a price per share of $17.50.
The following table sets forth the computation of pro forma basic and diluted
earnings per share:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
1999 1998 1999 1998
JUNE 30, (AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
(ACTUAL)(ACTUAL)(ACTUAL)(PRO FORMA)
<S> <C> <C> <C> <C>
Numerator:
Net income $4,668 $4,088 $9,089 $7,120
====== ====== ====== ======
Denominator:
Denominator for basic earnings
per share:
Weighted average shares 15,627 15,414 15,625 14,193
Weighted average shares required
to pay stockholder dividend - - - 636
------ ------ ------ ------
Denominator for basic earnings
per share 15,627 15,414 15,625 14,829
------ ------ ------ ------
Effect of dilutive securities:
Employee stock options 434 524 442 542
------ ------ ------ ------
Denominator for diluted earnings
per share 16,061 15,938 16,067 15,371
====== ====== ====== ======
Earnings per share:
Basic $ .30 $ .27 $ .58 $ .48
====== ====== ====== ======
Diluted $ .29 $ .26 $ .57 $ .46
====== ====== ====== ======
</TABLE>
The following stock options to purchase Common Stock were excluded from the
computation of diluted earnings per share for the three months ended June 30,
1999 and 1998 because the effect of the options on the calculation would have
been anti-dilutive:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, (AMOUNTS IN THOUSANDS) 1999 1998 1999 1998
- ------------------------------- ----- ----- ----- -----
<S> <C> <C> <C> <C>
Anti-dilutive stock options 902 506 878 3
===== ===== ===== ====
</TABLE>
NOTE 6 - REPORTING COMPREHENSIVE INCOME
- ----------------------------------------
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires the reporting of comprehensive income in addition to net income.
Comprehensive income is a more inclusive financial reporting methodology that
includes disclosure of certain financial information that historically has not
been recognized in the calculation of net income. Based on the current financial
structure and operations of the Company, the Company had no other components to
be included in comprehensive income. Therefore, comprehensive income is the same
as net income reported for the six months ended June 30, 1999 and 1998.
<PAGE> -6-
NOTE 7 - RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
- --------------------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", adjusted to
be effective for fiscal years beginning after June 15, 2000. The new standard
requires that all companies record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. Management is
currently assessing the impact of SFAS No. 133 on the financial statements of
the Company. The Company will adopt this accounting standard on January 1, 2001,
as required.
NOTE 8 - ACQUISITION OF SUBSIDIARY
- -----------------------------------
On June 29, 1999, the Company acquired all of the outstanding stock of ComTeq
Federal, Inc., a supplier of computer equipment and services to federal
government agencies. The purchase price was $8.3 million, consisting of cash,
including acquisition costs, of $5.3 million and promissory notes aggregating $3
million. Total cash paid for ComTeq Federal, Inc. on June 29, 1999, net of cash
acquired, was $3.2 million. The transaction has been accounted for by the
purchase method, and the assets purchased and liabilities assumed have been
recorded at their fair value at date of acquisition. The excess of the purchase
price, including acquisition costs, over the fair value of the net assets
acquired has been recorded as goodwill. Such amount recorded at June 30, 1999 is
subject to change pending final valuation of the net assets acquired. Goodwill
will be amortized over a period of 15 years.
NOTE 9 - SEGMENT AND RELATED DISCLOSURES
- ----------------------------------------
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information", requires that public companies report profits and losses and
certain other information on its "reportable operating segments" in its annual
and interim financial statements.
Management has determined that the Company has only one "reportable operating
segment", given the financial information provided to and used by the "chief
decision maker" of the Company to allocate resources and assess the Company's
performance. However, senior management does monitor revenue by platform (PC vs.
Mac), sales channel (Corporate Outbound, Inbound Telesales and On-line
Internet), and product mix (Computer Systems and Memory, Peripherals, Software,
and Networking and Communications).
Net sales by platform, sales channel and product mix are presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, (AMOUNTS IN THOUSANDS) 1999 1998 1999 1998
------------------------------ ---- ---- ---- -----
<S> <C> <C> <C> <C>
Platform
--------
PC and Multi Platform $194,166 $141,002 $376,624 $276,858
Mac 37,667 33,347 80,188 66,134
-------- -------- -------- --------
Total $231,833 $174,349 $456,812 $342,992
======== ======== ======== ========
Sales Channel
-------------
Corporate Outbound $147,331 $ 96,403 $276,008 $181,685
Inbound Telesales 72,274 71,370 156,541 149,179
On-Line Internet 12,228 6,576 24,263 12,128
-------- -------- -------- --------
Total $231,833 $174,349 $456,812 $342,992
======== ======== ======== ========
Product Mix
-----------
Computer Systems and Memory $111,102 $ 73,941 $217,453 $143,511
Peripherals 74,891 59,245 150,537 119,132
Software 30,637 25,545 59,262 50,949
Networking and Communications 15,203 15,618 29,560 29,400
-------- -------- -------- --------
Total $231,833 $174,349 $456,812 $342,992
======== ======== ======== ========
</TABLE>
<PAGE> -7-
NOTE 9 - SEGMENT AND RELATED DISCLOSURES-CONT'D.
- ------------------------------------------------
Substantially, all of the Company's net sales for the quarters ended June 30,
1999 and 1998 were made to customers located in the United States. Shipments to
customers located in foreign countries aggregated less than 2% in those
respective quarters. All of the Company's assets at June 30, 1999 and December
31, 1998 were located in the United States. The Company's primary target
customers are small- to medium-size businesses ("SMBs") comprised of 20 to 1,000
employees, although its customers also include individual consumers, larger
companies, federal, state and local governmental agencies and educational
institutions. No single customer (including the federal government) accounted
for more than 2% of total net sales in the six months ended June 30, 1999 and
1998.
<PAGE> -8-
PC CONNECTION INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
- ---------
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements based on management's
current expectations, estimates and projections about the Company's industry,
management's beliefs and certain assumptions made by management. All statements,
trends, analyses and other information contained in this report relative to
trends in net sales, gross margin and anticipated expense levels, as well as
other statements, including words such as "anticipate", "believe," "plan,"
"estimate," "expect" and "intend" and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those anticipated
or expressed in such statements. Potential risks and uncertainties include,
among others, those set forth in Item 7 under the caption "Factors That May
Affect Future Results and Financial Condition" in the Company's Annual Report on
Form 10-K for the year ended December 31, 1998 filed with the SEC, which are
incorporated by reference herein. Particular attention should be paid to the
cautionary statements involving the industry's rapid technological change and
exposure to inventory obsolescence, availability and allocation of goods,
reliance on vendor support and relationships, continued sales of Mac products,
competitive risks, pricing risks, and economic risks. Except as required by law,
the Company undertakes no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise. Readers,
however, should carefully review the factors set forth in other reports or
documents that the Company files from time to time with the SEC.
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
("PCs"). 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, (ii) inbound calls from customers responding to the
Company's catalogs and other advertising and (iii) commencing in 1997, selling
products through its Internet web site.
The Company offers both PC compatible products and Mac personal computer
compatible products. Reliance on Mac product sales has decreased over the last
two and one-half years, from 23.0% of net sales for the year ended December 31,
1996 to 16.4% of net sales in the quarter ended June 30, 1999. Although net
sales attributable to Mac products increased by approximately by $4.4 million in
the quarter ended June 30, 1999, as compared to the comparable period in 1998,
the Mac percentage of total sales continued to decrease. The Company believes
that such sales will continue to decrease as a percentage of net sales and may
even decline in dollar volume in future periods.
All of the Company's product categories experienced strong growth in the quarter
ended June 30, 1999 over the comparable period in 1998, with sales of computer
systems representing one of the fastest growing categories. 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 $600 in the quarter ended June
30, 1998 to $741 in the quarter ended June 30, 1999. Computer system sales
generally provide the largest gross profit dollar contribution per order of all
of the Company's products, although they usually yield the lowest gross margin
percentage. Partially as a result of higher system sales, the Company's gross
margin has declined in 1999 over the comparable three and six month figures seen
in 1998, while the operating income margin has generally 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, outbound, and on-line Internet
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.
However, the gross profit dollar contribution per order is generally higher as
average order sizes of orders to corporate accounts are usually larger. The
Company believes that outbound and on-line Internet sales will continue to
represent a larger portion of its business mix in future periods.
<PAGE> -9-
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 ("Dell") and Gateway, Inc.
("Gateway"), manufacturers of PCs sold by the Company, such as Compaq and IBM,
have previously announced varying plans to sell PCs directly to end users. The
Company currently believes that direct sales by Compaq and IBM will not have a
significant adverse effect upon the Company's net sales.
On June 29, 1999, the Company completed its acquisition of ComTeq Federal, Inc.
The results of operations for the three and six month periods described below
include immaterial amounts of revenues and expenses relating to this acquisition
because only one day of operations was included for ComTeq.
RESULTS OF OPERATIONS
- ---------------------
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH THE THREE MONTHS
AND SIX MONTHS ENDED JUNE 30, 1998
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 periods ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 1998 1999 1998
- --------- ----- ----- ----- ----
<S> <C> <C> <C> <C>
Computer Systems/Memory 47.9% 42.4% 47.6% 41.8%
Peripherals 32.3 34.0 32.9 34.7
Software 13.2 14.6 13.0 14.9
Networking and Communications 6.6 9.0 6.5 8.6
----- ----- ----- -----
Total 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
</TABLE>
NET SALES increased $57.5 million, or 33.0%, to $231.8 million for the quarter
ended June 30, 1999 from $174.3 million for the comparable period in 1998. Net
sales for the six months ended June 30, 1999 increased $113.8 million, or 33.2%,
to $456.8 million from $343.0 million for the comparable period in 1998. Growth
in net sales was primarily attributable to the continued expansion and increased
productivity of the Company's outbound telemarketing group, continued growth in
average order size, an increase in the number of catalog mailings and growth in
the Company's Internet sales. Outbound sales increased $50.9 million, or 52.8%,
to $147.3 million in the three months ended June 30, 1999 from $96.4 million in
the three months ended June 30, 1998. While Inbound sales for the quarter, at
$72.3 million, grew modestly over the prior year quarter, On-line Internet sales
increased $5.7 million or 86.0%, to $12.2 million in the three months ended June
30, 1999 from $6.6 million in the three months ended June 30, 1998. Outbound
sales for the six months ended June 30, 1999 increased $94.3 million, or 51.9%,
to $276.0 million from $181.7 million for the comparable period in 1998 and
inbound and on-line Internet sales increased $19.5 million, or 12.1%, to $180.8
million, from $161.3 million in the comparable period in 1998. Computer
system/memory sales increased to 47.9% and 47.6% of net sales for the three
months and six months ended June 30, 1999, respectively, from 42.4% and 41.8%
for the respective comparable periods in 1998.
GROSS PROFIT increased $5.2 million, or 23.0%, to $27.8 million for the quarter
ended June 30, 1999 from $22.6 million for the comparable quarter in 1998. Gross
profit for the six months ended June 30, 1999 increased $10.3 million, or 23.1%,
to $54.9 million from $44.5 million for the comparable period in 1998. The
increase in gross profit dollars was primarily attributable to the increase in
net sales described above. Gross profit margin decreased from 13.0% each for the
three and six months ended June 30, 1998 to 12.0% each for the three and six
months ended June 30, 1999, due primarily to the continued decline in margins
for system sales and growth in outbound telemarketing sales, which generally
carry lower margins. During 1999, certain product manufacturers changed the
focus of their vendor support programs from providing general cooperative
advertising dollars to issuing rebates based on specified product sell through.
The effect of this change in vendor focus impacted both cost of sales and
selling, general and administrative expenses, because rebates are accounted for
as credits to cost of sales
<PAGE> -10-
and cooperative advertising revenue is credited to advertising expense.
Therefore, in 1999, gross margins have been positively impacted by such rebate
activity while selling, general and administrative expenses have been negatively
impacted. The Company anticipates that this trend may continue in the future.
The Company expects that its gross margin in the future is likely to fluctuate
and may decline from the level achieved in the first and second quarters of 1999
since it is dependent upon several variables including vendor support programs,
product mix, pricing strategies, market conditions and other factors.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased $4.0 million, or 25.0%,
to $20.0 million for the quarter ended June 30, 1998 from $16.0 million for the
comparable quarter in 1998, but decreased as a percentage of sales from 9.2% for
the three months ended June 30, 1998 to 8.6% for the three months ended June 30,
1999. Such expenses for the six months ended June 30, 1999 increased by $6.9
million, or 21.0%, to $39.8 million from $32.9 million in the six months ended
June 30, 1998, but decreased as a percentage of sales to 8.7% for the six months
ended June 30, 1999 from 9.6% in the comparable period in 1998. However, the
1998 six month period included a $870,000 one-time charge for stock option
compensation expense relating to the acceleration in the vesting period of
certain of the Company's stock options from seven to four years in connection
with the Company's initial public offering of its shares. 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 was $0 for the three months and six
months ended June 30, 1999, respectively, compared to $0 and $2.4 million for
the respective comparable periods in 1998. These amounts generally represented
Company-related federal income tax obligations payable by the
stockholder/officers for periods prior to March 6, 1998, the point in time that
the Company converted from an S Corporation to a C Corporation.
INCOME FROM OPERATIONS increased $1.3 million, or 20.0%, to $7.8 million for the
quarter ended June 30, 1999, from $6.5 million for the quarter ended June 30,
1998. Income from operations as a percentage of sales decreased from 3.8% in the
three months ended June 30, 1998 to 3.4% in the comparable period in 1999 for
the reasons discussed above. Similarly, income from operations for the six
months ended June 30, 1999 increased $5.8 million, or 62.4%, to $15.1 million
from $9.3 million in the comparable 1998 period. Income from operations as a
percentage of sales increased from 2.7% for the six months ended June 30, 1998
to 3.3% for the comparable period in 1999, primarily as a result of the
additional 1998 stockholder/officer compensation referred to above.
Income from operations, excluding both the one-time charge for stock option
compensation expense ($870,000) and the additional stockholder/officer
compensation ($2.4 million) for the six months ended June 30, 1999, increased by
$2.5 million, or 20%, to $15.1 million for the six months ended June 30, 1999
from $12.5 million for the comparable period in 1998. Such income from
operations as a percentage of net sales decreased from 3.6% for the six-month
period ended June 30, 1998 to 3.3% for the comparable period in 1999.
INTEREST EXPENSE increased $225,000, or 441%, to $276,000 for the quarter ended
June 30, 1999 from $51,000, for the comparable quarter in 1998. Similarly,
interest expense for the six months ended June 30, 1999, increased $285,000, or
111%, to $542,000 from $257,000 for the comparable period in 1998. This increase
in interest expense was due primarily to higher average outstanding borrowings
generally in the six months ended June 30, 1999, and the commencement of the
Company's capital lease obligation to an affiliate, effective December 1998.
INCOME TAXES for three months ended June 30, 1999 was a provision of $2.9
million compared to a provision of $2.6 million for the comparable quarter in
1998. Income taxes for the six months ended June 30, 1999 was a provision of
$5.6 million, compared to a benefit of $1.2 million for the comparable period in
1998. The six month period ended June 30, 1998 was impacted by the Company's
status as a Subchapter S Corporation since there were no federal taxes provided
for from the period January 1, 1998 to March 6, 1998.
<PAGE> -11-
NET INCOME for the quarter ended June 30, 1999 increased $0.6 million, or 14.2%,
to $4.7 million from $4.1 million for the comparable quarter in 1998,
principally as a result of the increases in operating income as described above.
Net income for the six months ended June 30, 1999 decreased $1.4 million, or
13.4%, to $9.1 million from $10.5 million for the comparable period in 1998,
principally as a result of a $1.2 million income tax benefit in the 1998 period.
PRO FORMA NET INCOME calculated for the six months ended June 30, 1998, is
determined by (i) eliminating stockholder/officer compensation in excess of
quarterly base salaries ($150,000) and (ii) by eliminating the actual income tax
provision/benefit and adding a provision for federal and state income taxes that
would have been payable by the Company under Subchapter C of the Internal
Revenue Code ("Code"). Net income for the six months ended June 30, 1999 was
$9.1 million, or $.57 per share, compared to pro forma net income for the
quarter ended June 30, 1998 of $7.1 million, or $.46 per share.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company has historically financed its operations and capital expenditures
through cash flow from operations and bank borrowings. In March 1998, the
Company completed an initial public offering and used the net proceeds of the
Offering, aggregating $57.3 million, to repay all outstanding bank indebtedness
of $12.9 million and to pay a dividend of $33.0 million to its then current
stockholders, equal to substantially all previously taxed, but undistributed, S
Corporation earnings of the Company. The remaining net proceeds of $11.4 million
were invested in short-term investment securities and were used for general
corporate purposes. 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 1999. 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.
Net cash used for operating activities was $2.3 million for the six months ended
June 30, 1999, as compared to $34.5 million provided in the comparable period in
1998. 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. 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.
Historically, inventories and accounts payable had increased as a result of the
sales growth of the Company; however, inventory and accounts payable actually
decreased in the six months ended June 30, 1999 by $1.2 million and $7.3
million, respectively, compared to a $4.8 million decrease in inventory and an
increase in accounts payable of $27.0 million in the comparable period in 1998.
The reductions in inventory levels related to continued steps taken to improve
inventory turns while the change in accounts payable is due to the timing of
payments with vendors.
At June 30, 1999, the Company had cash and cash equivalents of $3.2 million and
working capital of $54.4 million. At December 31, 1998, the Company had cash and
cash equivalents of $11.9 million and working capital of $53.8 million.
The Company used cash and cash equivalents of $3.2 million for the acquisition
of its new subsidiary, ComTeq Federal, Inc. in 1999. Additionally, capital
expenditures were $3.4 million in the six months ended June 30, 1999, as
compared to $3.6 million in the comparable period in 1998. The majority of the
capital expenditures for the respective 1999 and 1998 periods relate to computer
hardware and software for the Company's management information systems. The
Company upgraded its order management and fulfillment systems to new hardware
and software. The conversion was completed during the third quarter of 1998.
Additional enhancements to increase functionality of the system have occurred
throughout 1999. Total capital expenditures for the year ending December 31,
1999 are estimated at $10.0 million.
The Company has an unsecured credit agreement with a bank providing for short-
term borrowings up to $50 million, which bears interest at various rates ranging
from the prime rate (7.75% at June 30, 1999) to prime less 1%, depending on the
ratio of senior debt to EBITDA. The credit agreement includes various customary
financial and operating covenants, including restrictions on the payment of
dividends, none of which the Company believes significantly restricts its
operations. No borrowings were outstanding at June 30, 1999.
<PAGE> -12-
The Company had $78.3 million in outstanding accounts payable at June 30, 1999,
including $6.0 million for in-transit inventory from vendors not yet received by
the Company but for which title passed to the Company upon shipment. 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.
YEAR 2000 COMPLIANT INFORMATION SYSTEMS
- ---------------------------------------
The change in date from 1999 to 2000 poses potential problems for many computer
and electro-mechanical systems around the world. Some of the Company's systems
could be affected by this problem which could have a material adverse effect on
the Company's business, financial condition and results of operations.
In order to minimize any potential disruption to the Company's business, the
Company has an active, on-going program to evaluate its systems and take
corrective action prior to the millennium change. A full-time senior manager is
responsible for managing the Year 2000 Project, which is comprised of five
phases: awareness, assessment, renovation, validation and implementation. For
each system that is determined to be non-compliant, the Company is taking one of
the following three courses of action to achieve date compliance: (i) renovate
(convert) the current system; (ii) replace the current system with a new date
compliant system; or (iii) retire the current system because it no longer serves
a valid business need.
In 1998, the Company replaced its order management and fulfillment software with
new software and converted its principal computer equipment to new IBM AS400
platform systems, both of which are better suited to the Company's expected
scale of operations and are designed to be Year 2000 compliant. The Company is
investigating the extent to which its other systems may be affected and
communicating to all of its system vendors concerning timely completion of
remedies for those systems requiring modification. The Company currently
believes it will be able to modify or replace any affected systems in time to
minimize any detrimental effect on operations.
The Company has communicated with all third parties on which it relies to assess
their progress in evaluating their systems and implementing appropriate
corrective measures, and such assessments are expected to be completed by
September 30, 1999. Furthermore, the Company is actively encouraging its
customers to undertake their own Year 2000 compliance projects in order to
ensure the continued viability of the Company's commercial business pursuits.
The Company has been taking, and will continue to pursue, all steps it believes
are reasonably necessary to protect its operations, assets and the interests of
its customers, shareholders, employees and community partners.
Utilizing both internal and external resources to identify and assess needed
Year 2000 remediation, the Company currently anticipates that its Year 2000
awareness, assessment, renovation and validation efforts, which began in 1996,
will be completed by September 30, 1999, and that such efforts will be completed
prior to any currently anticipated impact on its computer equipment and
software. The Company estimates that as of June 30, 1999, it had completed
approximately 95% of the initiatives that it believes will be necessary to fully
address potential Year 2000 issues relating to its computer equipment and
software. The majority of the projects comprising the remaining 5% of the
initiatives are in process and are currently expected to be substantially
completed by September 30, 1999.
<PAGE> -13-
<TABLE>
<CAPTION>
TIME PERCENT
FRAME COMPLETED
----- ---------
Status of overall Year 2000 Project:
<S> <C> <C>
Awareness 10/97 - 06/98 100%
Assessment 10/97 - 12/98 100%
Renovation 04/98 - 09/99 95%
Validation 05/98 - 11/99 95%
Implementation 05/98 - 12/99 95%
Summary of significant Year 2000 projects completed:
Conversion to new IBM AS400 10/96 - 09/98 100%
Conversion to new order management
and fulfillment software 10/96 - 09/98 100%
The primary objectives of the Year 2000 Project relating to the Company's
internal systems were met when the Company implemented its new order management
and fulfillment software and upgraded its IBM AS400 data processing platform.
The majority of the costs (approximately $5.5 million) of the new software and
hardware were capitalized during the period October 1, 1997 to September 30,
1998. The Company believes that the costs of its Year 2000 awareness,
assessment, renovation, validation and implementation for all other computer
equipment and software, as well as currently anticipated costs to be incurred by
the Company with respect to Year 2000 issues of third parties, will not exceed
$300,000, which will be funded from operating cash flow. These costs will be
expensed as incurred and funded from working capital.
The Company presently believes that the Year 2000 issue will not pose
significant operational problems for the Company. However, for all Year 2000
issues that are not properly identified, or assessments, renovation, validation
and implementation are not effected timely with respect to Year 2000 problems,
there can be no assurance that the Year 2000 issues of other entities will not
have a material adverse impact on the Company's systems or results of
operations.
The Company is presently undertaking, a comprehensive analysis of the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with worst
case scenarios, and such scenarios have not yet been clearly identified. The
Company currently plans to complete such analysis and contingency planning
before December 31, 1999.
The costs of the Company's Year 2000 awareness, assessment, renovation,
validation and implementation efforts and the dates on which the Company
believes it will complete such efforts are based upon management's best
estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
remediation plans, and other factors. There can be no assurance that these
estimates will prove to be accurate and actual results could differ materially
from those currently anticipated. Specific factors that could cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in Year 2000 issues, the ability to assess, renovate and
implement all relevant computer codes and embedded technology and similar
uncertainties. In addition, variability of definitions of "Year 2000 Compliance"
and the myriad of different products and services and combinations thereof, sold
by the Company may lead to claims whose impact on the Company is not currently
estimable. No assurance can be given that the aggregate cost of defending and
resolving such claims, if any, will not materially adversely affect the
Company's results of operations. Although some of the Company's agreements with
manufacturers and others from whom it purchases products for resale contain
provisions requiring such parties to indemnify the Company under some
circumstances, there can be no assurance that such indemnification arrangements
will cover all of the Company's liabilities and costs related to claims by third
parties related to the Year 2000 issue.
<PAGE> -14-
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
- ----------------------------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", adjusted to be effective for fiscal years
beginning after June 15, 2000. The new standard requires that all companies
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. Management is currently assessing the
impact of SFAS No. 133 on the financial statements of the Company. The Company
will adopt this accounting standard on January 1, 2001, as required.
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.
<PAGE> -15-
PC CONNECTION, INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company invests cash balances in excess of operating requirements in short-
term securities, generally with maturities of 90 days or less. The Company
believes that the effect, if any, of reasonably possible near-term changes in
interest rates on the Company's financial position, results of operations and
cash flows should not be material.
<PAGE> -16-
PC CONNECTION, INC. AND SUBSIDIARY
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
- --------------------------
Not applicable
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
- --------------------------------------------------
Not applicable
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
- ----------------------------------------
Not applicable
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
(a) A total of 15,401,222 shares of Common Stock, out of a total of
15,624,956 shares of Common Stock of the Corporation entitled to
vote were represented in person or by proxy at the The Annual
Meeting of the Shareholders of the Company, held on May 26, 1999.
(b) The following individuals receiving 15,387,553 votes in favor or
their election, were elected as directors of the Company for terms
of one year each:
Patricia Gallup, David Hall, David B. Beffa-Negrini, Martin C. Murrer,
Peter J. Baxter.
(c) Other Matters
(i) Holders of 12,406,035 shares of Common Stock approved (i)
the continuance of the Company's 1997 Stock Incentive Plan
(the "1997 Plan") and (ii) the amendment and restatement of
the 1997 Plan to increase the number of shares of Common Stock
available to grant under the 1997 Plan by 800,000.
(ii) The selection of Deloitte & Touche LLP as the Company's
independent auditors for the current year was ratified with
a vote of 15,385,063 shares.
ITEM 5 - OTHER INFORMATION
- --------------------------
Not applicable
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) EXHIBITS
--------
Exhibit
Number Description
------ -----------
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
-------------------
(i) None
<PAGE> -17-
PC CONNECTION, INC. AND SUBSIDIARY
JUNE 30, 1999
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PC CONNECTION, INC.
August 9, 1999 By: /s/
------------------------------------
Wayne L. Wilson
President and Chief Operating Officer
August 9, 1999 By: /s/
--------------------------------------
Mark A. Gavin
Vice President of Finance and
Chief Financial Officer
<PAGE> -18-
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the June 30,
1999 Form 10-Q and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,235
<SECURITIES> 0
<RECEIVABLES> 81,761
<ALLOWANCES> 8,459
<INVENTORY> 62,837
<CURRENT-ASSETS> 145,068
<PP&E> 46,303
<DEPRECIATION> 22,517
<TOTAL-ASSETS> 178,939
<CURRENT-LIABILITIES> 90,628
<BONDS> 9,016
0
0
<COMMON> 156
<OTHER-SE> 79,139
<TOTAL-LIABILITY-AND-EQUITY> 178,939
<SALES> 456,812
<TOTAL-REVENUES> 456,812
<CGS> 401,947
<TOTAL-COSTS> 401,947
<OTHER-EXPENSES> (141)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 542
<INCOME-PRETAX> 14,661
<INCOME-TAX> 5,572
<INCOME-CONTINUING> 9,089
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,089
<EPS-BASIC> .58
<EPS-DILUTED> .57
</TABLE>
