================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE COMMISSION Commission File Number 0-23827 PC CONNECTION, INC. (Exact name of registrant as specified in its charter) Delaware 02-0497006 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Rt. 101A, 730 Milford Road Merrimack, New Hampshire 03054 ------------------------ ----- (Address of principal executive offices) (Zip Code) (603) 423-2000 -------------- Registrant's telephone number, including area code ------------------------------------------ Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |_| The aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant, based upon the closing price of the Registrant's Common Stock as reported on the NASDAQ National Market on March 27, 2000, was $96,008,036. Although directors and executive officers of the registrant were assumed to be "affiliates" of the registrant for the purposes of this calculation, this classification is not to be interpreted as an admission of such status. The number of outstanding shares of the Registrant's Common Stock on March 27, 2000 was 15,794,298. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the 2000 Annual Meeting of Shareholders for the fiscal year ended December 31, 1999, which is to be filed within 120 days of the end of the Company's fiscal year, are incorporated by reference into Part III of this Form 10-K. The incorporation by reference herein of portions of the Proxy Statement shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a) (8) of Regulation S-K. ================================================================================
PC CONNECTION, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS <TABLE> <CAPTION> Page ---- <S> <C> Report of Management........................................................................................F-2 Independent Auditors' Report................................................................................F-3 Consolidated Balance Sheets as of December 31, 1999 and 1998................................................F-4 Consolidated Statements of Income for the years ended December 31, 1999, 1998, and 1997.....................F-5 Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 1999, 1998, and 1997......................................................................................F-6 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998, and 1997.................F-7 Notes to Consolidated Financial Statements..................................................................F-8 </TABLE> F-1
REPORT OF MANAGEMENT Responsibility for the integrity and objectivity of the financial information presented in this Annual Report on Form 10-K rests with PC Connection, Inc. and subsidiary ("the Company") management. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, applying certain estimates and judgments as required. The Company maintains an effective internal control structure. It consists, in part, of an organization with clearly defined lines of responsibility and delegation of authority, comprehensive systems and control procedures. We believe this structure provides reasonable assurance that transactions are executed in accordance with management authorization and generally accepted accounting principles. To assure the effective administration of internal control, we carefully select and train our employees, develop and disseminate written policies and procedures, provide appropriate communication channels and foster an environment conducive to the effective functioning of controls. We believe that it is essential for the Company to conduct its business affairs in accordance with the highest ethical standards. Deloitte & Touche LLP, independent auditors, is retained to audit the Company's consolidated financial statements. Its accompanying report is based on an audit conducted in accordance with auditing standards generally accepted in the United States of America. The Audit Committee of the Board of Directors is composed solely of outside directors and is responsible for recommending to the Board of Directors the independent accounting firm to be retained for the coming year. The Audit Committee meets periodically and privately with the independent auditors, as well as with Company management, to review accounting, auditing, internal control structure and financial reporting matters. Patricia Gallup Wayne L. Wilson Mark A. Gavin Chairman and President and Chief Chief Financial Officer Chief Executive Officer Operating Officer F-2
INDEPENDENT AUDITORS' REPORT To the Board of Directors of PC Connection, Inc. and Subsidiary Merrimack, New Hampshire We have audited the accompanying consolidated balance sheets of PC Connection, Inc. and subsidiary as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in Item 14(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements present fairly, in all material respects, the financial position of PC Connection, Inc. and subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Deloitte & Touche LLP Boston, Massachusetts January 26, 2000 F-3
PC CONNECTION, INC. CONSOLIDATED BALANCE SHEETS (amounts in thousands, except per share data) <TABLE> <CAPTION> December 31, -------------------- 1999 1998 -------- -------- ASSETS Current Assets: <S> <C> <C> Cash and cash equivalents .................................................... $ 20,416 $ 11,910 Accounts receivable, net ..................................................... 99,405 58,890 Inventories - merchandise .................................................... 64,348 63,425 Deferred income taxes ........................................................ 1,991 3,181 Prepaid expenses and other current assets .................................... 4,651 4,115 -------- -------- Total current assets ............................................... 190,811 141,521 Property and equipment, net ...................................................... 23,126 22,675 Deferred income taxes ............................................................ -- 314 Other assets ..................................................................... 169 -- Goodwill ......................................................................... 9,431 -- -------- -------- Total Assets ....................................................... $223,537 $164,510 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current maturities of capital lease obligation to affiliate .............................................................. $ 137 $ 123 Current maturities of long-term debt ......................................... 1,000 -- Accounts payable ............................................................. 105,547 77,561 Accrued expenses and other liabilities ....................................... 11,877 10,069 -------- -------- Total current liabilities .......................................... 118,561 87,753 Notes payable, less current maturities ........................................... 2,000 -- Capital lease obligation to affiliate, less current maturities ................... 6,945 7,081 Deferred taxes ................................................................... 1,579 -- Other liabilities ................................................................ 229 -- -------- -------- Total Liabilities .................................................. 129,314 94,834 -------- -------- Commitments and Contingencies (Note 11) Stockholders' Equity: Preferred Stock, $.01 par value, 7,500 shares authorized, 0 outstanding at December 31, 1999 and December 31, 1998 ............................. -- -- Common Stock, $.01 par value, 30,000 shares authorized, 15,767 and 15,605 issued and outstanding at December 31, 1999 and December 31, 1998, respectively .................................... 158 156 Additional paid-in capital ................................................... 58,627 56,812 Retained earnings ............................................................ 35,438 12,708 -------- -------- Total Stockholders' Equity ............................................ 94,223 69,676 -------- -------- Total Liabilities and Stockholders' Equity ............................ $223,537 $164,510 ======== ======== </TABLE> See notes to consolidated financial statements. F-4
PC CONNECTION, INC. CONSOLIDATED STATEMENTS OF INCOME (amounts in thousands, except per share data) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- <S> <C> <C> <C> Net sales ...................................... $ 1,056,704 $ 732,370 $ 550,575 Cost of sales .................................. 927,358 639,096 474,609 ----------- ----------- ----------- Gross Profit ............................... 129,346 93,274 75,966 Selling, general and administrative expenses ... 91,405 68,521 56,596 Additional stockholder/officer compensation .... -- 2,354 12,130 ----------- ----------- ----------- Income from operations .................... 37,941 22,399 7,240 Interest expense ............................... (1,392) (415) (1,355) Other, net ..................................... 116 565 (42) ----------- ----------- ----------- Income before taxes ............................ 36,665 22,549 5,843 Income taxes ................................... (13,935) (3,905) (639) ----------- ----------- ----------- Net income ................................ $ 22,730 $ 18,644 $ 5,204 =========== =========== =========== Earnings per common share: Basic ..................................... $ 1.45 =========== Diluted ................................... $ 1.41 =========== Pro forma data: Historical income before income taxes ....... $ 22,549 $ 5,843 Pro forma other adjustments ................. 2,354 12,010 ----------- ----------- Pro forma income before income taxes ........ 24,903 17,853 Pro forma income taxes ...................... 9,631 6,963 ----------- ----------- Pro forma net income ........................ $ 15,272 $ 10,890 =========== =========== Pro forma basic net income per share ........ $ 1.01 $ .79 =========== =========== Pro forma diluted net income per share ...... $ .98 $ .76 =========== =========== </TABLE> See notes to consolidated financial statements. F-5
PC CONNECTION, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (amounts in thousands) <TABLE> <CAPTION> Additional Common Stock Paid-In Retained Shares Amount Capital Earnings Total -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> Balance, January 1, 1997 .................... 11,799 $ 118 $ 3,224 $ 14,701 $ 18,043 Compensation under nonstatutory stock option agreements ....................... -- -- 873 -- 873 Net Income .................................. -- -- -- 5,204 5,204 -------- -------- -------- -------- -------- Balance, December 31, 1997 .................. 11,799 118 4,097 19,905 24,120 -------- -------- -------- -------- -------- Net proceeds from initial public offering ... 3,594 36 57,217 -- 57,253 Dividend .................................... -- -- (7,196) (25,841) (33,037) Exercise of stock options, including income tax benefits ..................... 212 2 1,397 -- 1,399 Compensation under nonstatutory stock option agreements ................. -- -- 1,297 -- 1,297 Net income .................................. -- -- -- 18,644 18,644 -------- -------- -------- -------- -------- Balance, December 31, 1998 .................. 15,605 156 56,812 12,708 69,676 -------- -------- -------- -------- -------- Exercise of stock options, including income tax benefits ..................... 117 1 1,183 -- 1,184 Issuance of stock under employee stock purchase plan ..................... 45 1 470 -- 471 Compensation under nonstatutory stock option agreements ................. -- -- 162 -- 162 Net income .................................. -- -- -- 22,730 22,730 -------- -------- -------- -------- -------- Balance, December 31, 1999 .................. 15,767 $ 158 $ 58,627 $ 35,438 $ 94,223 ======== ======== ======== ======== ======== </TABLE> See notes to consolidated financial statements. F-6
PC CONNECTION, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands) <TABLE> <CAPTION> Years Ended December 31, ------------------------------------- 1999 1998 1997 --------- --------- --------- <S> <C> <C> <C> Cash Flows from Operating Activities: Net income .................................................... $ 22,730 $ 18,644 $ 5,204 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Depreciation and amortization ............................. 5,334 2,866 3,660 Deferred income taxes ..................................... 2,523 (1,945) (154) Compensation under nonstatutory stock option agreements ... 162 1,297 873 Provision for doubtful accounts ........................... 6,821 6,296 3,339 Loss on disposal of fixed assets .......................... 159 -- 54 Changes in assets and liabilities: Accounts receivable ....................................... (42,795) (35,265) (10,097) Inventories ............................................... (305) 295 (19,301) Prepaid expenses and other current assets ................. (504) (1,910) (483) Accounts payable .......................................... 19,945 39,387 1,269 Amounts payable to stockholders ........................... -- (1,185) 1,185 Accrued expenses and other liabilities .................... 1,969 926 4,042 --------- --------- --------- Net cash provided by (used for) operating activities .......... 16,039 29,406 (10,409) --------- --------- --------- Cash Flows from Investing Activities: Purchases of property and equipment ........................... (7,653) (9,922) (4,528) Proceeds from sale of property and equipment .................. 2,155 58 22 Payment for purchase of ComTeq, net of cash acquired .......... (3,198) -- -- --------- --------- --------- Net cash used for investing activities ........................ (8,696) (9,864) (4,506) --------- --------- --------- Cash Flows from Financing Activities: Proceeds from short-term borrowings ........................... 442,731 160,098 178,362 Repayment of short-term borrowings ............................ (442,731) (188,416) (162,351) Repayment of term loan ........................................ -- (4,500) (500) Repayment of capital lease obligation to affiliate ............ (122) (11) -- Issuance of stock upon exercise of stock options .............. 814 223 -- Issuance of stock under Employee Stock Purchase Plan .......... 471 -- -- Net proceeds from initial public offering ..................... -- 57,253 -- Payment of dividend ........................................... -- (33,037) -- --------- --------- --------- Net cash provided by (used for) financing activities .......... 1,163 (8,390) 15,511 --------- --------- --------- Increase in cash and cash equivalents ......................... 8,506 11,152 596 Cash and cash equivalents, beginning of period ................ 11,910 758 162 --------- --------- --------- Cash and cash equivalents, end of period ...................... $ 20,416 $ 11,910 $ 758 ========= ========= ========= Supplemental Cash Flow Information: Interest paid ................................................. $ 1,398 $ 497 $ 1,334 Income taxes paid ............................................. 9,374 7,275 550 Non-Cash Activities: Issuance of notes payable in connection with acquisition of subsidiary .................................. $ 3,000 $ -- $ -- Assets acquired under capital lease ........................... -- 7,215 -- </TABLE> See notes to consolidated financial statements. F-7
PC CONNECTION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PC Connection, Inc. and its subsidiary (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. Principles of Consolidation The Consolidated Financial Statements include the accounts of PC Connection, Inc. and its wholly-owned subsidiary. Intercompany transactions and balances are eliminated in consolidation. 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 point of shipment. A reserve for sales returns is recorded at the time of sale and has been established based upon historical trends. 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. The carrying value of the Company's cash equivalents approximates fair value. 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 $31,487, $32,498 and $27,859 for the years ended December 31, 1999, 1998 and 1997, respectively. Deferred advertising revenues at December 31, 1999 and 1998 exceeded deferred advertising costs of $423 and $325 at those respective dates, 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 and amortization is provided for both financial and income tax reporting purposes over the estimated useful lives of the assets ranging from three to seven years, computer software, including licenses and internally developed software is capitalized and amortized over lives ranging from three to five years. Depreciation is and has been provided using accelerated methods for property acquired prior to 1996 and on the straight-line method for property acquired thereafter. Leasehold improvements and facilities under capital leases 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 cash flows will be less than the asset carrying value. F-8
Goodwill Goodwill arises from certain purchase transactions and is amortized using the straight-line method over appropriate periods not exceeding 15 years. The amount charged to expense during 1999 was $324. Tax Status and Income Taxes For periods prior to March 6, 1998, the Company elected to be treated as an S Corporation under Subchapter S of the Internal Revenue Code (the "Code"), and applicable state laws. Effective with the consummation of the Company's initial public offering of its common stock on March 6, 1998 (the "Offering"), the Company's S Corporation election was automatically terminated and the Company became subject to federal and state income taxes as a C Corporation from that date forward. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis 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" as presented on the Consolidated Statements of Income comprise the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. 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 (the "Board") and generally represents Company-related federal income tax obligations payable by the stockholders for periods during which the Company was an S Corporation. 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. Earnings Per Share Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted, when dilutive, for the incremental shares attributed to outstanding options to purchase common stock. The denominator pro forma basic earnings per share for all periods prior to March 6, 1998 includes the weighted average shares required to pay the S Corporation dividend (assuming a price per share of $17.50 for the year ended December 31, 1998 and $16.00 for the year ended December 31, 1997). The following table sets forth the computation of basis and diluted earnings per share: <TABLE> <CAPTION> Pro Forma --------- (amounts in thousands, except per share data) 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> Numerator: Net income ........................................................ $22,730 $15,272 $10,890 Denominator: Denominator for basic earnings per share: Weighted average shares ........................................ 15,650 14,849 11,799 Weighted average shares required to pay stockholder dividend ... -- 316 2,062 ------- ------- ------- Denominator for basic earnings per share .......................... 15,650 15,165 13,861 ------- ------- ------- Effect of dilutive securities: Employee stock options ......................................... 461 504 383 ------- ------- ------- Denominator for diluted earnings per share ........................... 16,111 15,669 14,244 ======= ======= ======= Earnings per share: Basic .............................................................. $ 1.45 $ 1.01 $ .79 ======= ======= ======= Diluted ............................................................ $ 1.41 $ .98 $ .76 ======= ======= ======= </TABLE> The above pro forma adjustments have been made to the historical results of operations for the period from January 1 through March 5, 1998 and the year ended December 31, 1997 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 in excess of aggregate annual base salaries of $600 that were in effect during 1998 in accordance with employment agreements; and (ii) Computation of income tax expense assuming an effective tax rate of approximately 39% (see Note9) and after adjusting stockholder/officer compensation expense described in (i) above. F-9
The following stock options to purchase Common Stock were excluded from the computation of diluted earnings per share for years ended December 31, 1999, 1998, and 1997 because the effect of the options on the calculation would have been anti-dilutive: 1999 1998 1997 ---- ---- ---- Anti-dilutive stock options -- 78 -- 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 Board estimated the fair value of the Company's stock for awards made prior to the Offering using market valuations of comparable publicly traded companies, among other factors. Comprehensive Income Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income", which requires businesses to disclose comprehensive income and its components in their general-purpose financial statements. The Company has no other comprehensive income in any of the periods presented. Accordingly, a separate statement of comprehensive income is not presented. Recently Issued Financial Accounting Standards In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", effective for fiscal years beginning after June 15, 1999. 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. Reclassifications Certain amounts in the 1998 and 1997 financial statements have been reclassified to conform to the 1999 presentation. 2. 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, including acquisition costs and consisted of cash of $5.3 million and promissory notes aggregating $3 million. Total cash paid for ComTeq Federal Inc., net of cash acquired, was $3.2 million. The transaction has been accounted for by the purchase method, and accordingly, the results of operations for the period from June 29, 1999 are included in the accompanying financial statements. The assets purchased and liabilities assumed have been recorded at their fair value at the date of acquisition. The excess of the purchase price, including acquisition costs, over the fair value of the net liabilities assumed has been recorded as goodwill (approximately $9.7 million). Such amount recorded at December 31, 1999 is subject to change pending final valuation of the net assets acquired. Goodwill will be amortized over a period of 15 years. The promissory notes are unsecured, bear interest at the prime rate less 0.5% and are scheduled to be repaid over a three year period. As of December 31, 1999, the short-term portion of the promissory notes was $1 million and the long-term portion was $2 million. Pro Forma Information The following unaudited pro forma information presents the consolidated results of operations of the Company as if the acquisition of ComTeq Federal, Inc. had taken place as of the beginning of each of the periods presented. Year Ended December 31, (in thousands except per share data) 1999 1998 ---- ---- Revenues $1,081,533 $769,567 Net income 23,350 14,647 Diluted earnings per share 1.45 .93 F-10
3. ACCOUNTS RECEIVABLE Accounts receivable consisted of the following: December 31, ----------------------- 1999 1998 --------- --------- Trade ............................................ $ 96,981 $ 47,667 Co-op advertising ................................ 2,965 6,131 Vendor returns, rebates and other ................ 7,109 14,243 --------- --------- Total ................................... 107,055 68,041 Less allowances for: Sales returns ........................... (3,717) (4,030) Doubtful accounts ....................... (3,933) (5,121) --------- --------- Accounts receivable, net ......................... $ 99,405 $ 58,890 ========= ========= 4. PROPERTY AND EQUIPMENT Property and equipment consisted of the following: <TABLE> <CAPTION> December 31, --------------------- 1999 1998 -------- -------- <S> <C> <C> Facilities under capital lease ................................... $ 7,215 $ 7,215 Leasehold improvements ........................................... 5,337 5,225 Furniture and equipment .......................................... 22,923 22,484 Computer software, including licenses and internally-developed software ..................................................... 10,749 7,873 Automobiles ...................................................... 224 192 -------- -------- Total ................................................... 46,448 42,989 Less accumulated depreciation and amortization ................... (23,322) (20,314) -------- -------- Property and equipment, net ...................................... $ 23,126 $ 22,675 ======== ======== </TABLE> 5. BANK BORROWINGS At December 31, 1999, the Company has an unsecured credit agreement with a bank providing for short-term borrowing up to $50 million which bears interest at various rates ranging from the prime rate (8.50% at December 31, 1999) to prime rate less 1% depending on the ratio of senior debt to EBITDA. The credit agreement includes various customary financial and operating covenants, including minimum net worth requirements, minimum net income requirements and restrictions on the payment of dividends, none of which, in the opinion of management, significantly restricts the Company's operations. No amounts were outstanding under this facility at December 31, 1999. The credit agreement matures on May 31, 2002. Certain information with respect to short-term borrowings were as follows: <TABLE> <CAPTION> Weighted Average Maximum Amount Average Amount Interest Rate Outstanding Outstanding ------------- ----------- ----------- <S> <C> <C> <C> Year ended December 31, 1999................................ 7.4% $ 29,543 $ 4,497 1998................................ 8.2 28,307 4,145 1997................................ 8.6 31,890 9,458 </TABLE> 6. TRADE CREDIT ARRANGEMENTS At December 31, 1999 and 1998, 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 aggregated amount of $54.5 million. The cost of such financing under these agreements is borne by the suppliers. At December 31, 1999 and 1998, accounts payable included $31,064 and $21,820, respectively owed to these financial institutions. F-11
7. CAPITAL LEASE 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 occupied the facility upon completion of construction in late November 1998, and the lease payments commenced in December 1998. Annual lease payments under the terms of the lease, as amended, will be approximately $911 for the first five years of the lease, increasing to $1,025 for years six through ten and $1,139 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. In December 1998, the Company recorded the lease as a capital lease. The recorded value of the asset (facilities under capital lease) and the related liability (capital lease obligation to affiliate) was $7.2 million, and during 1999 and 1998, the Company made principal and interest payments under this lease aggregating $911 thousand and $76 thousand, respectively. Future aggregate minimum annual lease payments under this lease at December 31, 1999 are as follows: <TABLE> <CAPTION> Year Ending December 31 Payments ----------------------- --------- <S> <C> 2000...................................................................... $ 911 2001...................................................................... 911 2002...................................................................... 911 2003...................................................................... 921 2004...................................................................... 1,025 2005 and thereafter....................................................... 9,714 --------- Total minimum payments (excluding taxes, maintenance and insurance)....... 14,393 Less amount representing interest......................................... (7,311) --------- Present value of minimum lease payments................................... 7,082 Less current maturities................................................... (137) --------- Long-term portion......................................................... $ 6,945 ========= </TABLE> 8. STOCKHOLDERS' EQUITY Recapitalization and Reincorporation 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. Reincorporation of the Company Contemporaneous with the consummation of the Company's initial public offering (the"offering"), the Company was reincorporated in Delaware. All of the issued and outstanding shares of Series A Non-Voting Common Stock, $0.1 par value per share, and Series B Voting Common Stock, $.01 par value per share, of the New Hampshire corporation were converted into 11,798,793 shares of Common Stock, $.01 par value, of the Delaware corporation on a one-for-one basis, and the Series A and Series B shares were canceled. The effect of the conversion has been reflected in the Consolidated Statement of Changes in Stockholders' Equity for all periods presented. Preferred Stock The Amended and Restated Certificate of Incorporation of the Delaware Corporation (the "Restated Certificate") authorized 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, redemption privileges and liquidation preferences, as shall be determined by the Board. There were no preferred shares outstanding at 1999 and 1998. F-12
Incentive and Non-Statutory Stock Option Plans In December 1993, the Board adopted and the stockholders approved the 1993 Incentive and Non-Statutory Stock Option Plan (the "1993 Plan"). Under the terms of the 1993 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 stock. A total of 1,124,163 shares of the Company's Common Stock was authorized for issuance upon exercise of options granted or awards made under the 1993 Plan. Options vest over varying periods up to four years and have contractual lives up to ten years. In November 1997, the Board adopted and the stockholders approved the 1997 Stock Incentive Plan (the "1997 Plan"), which became effective on the closing of the Offering, and 800,000 shares were reserved for issuance under the Plan. The 1997 Plan 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. In April 1999, the Board adopted, and in May 1999 the stockholders approved, an additional 800,000 shares of Common Stock for issuance under the 1997 Plan. Information regarding the 1993 and 1997 Plans is as follows: <TABLE> <CAPTION> Weighted Average Weighted Option Exercise Average Shares Price Fair Value ------ ----- ---------- <S> <C> <C> <C> Outstanding, January 1, 1997................................. 589,940 1.89 4.22 Granted............................................. 504,070 4.97 Outstanding, December 31, 1997............................... 1,094,010 3.31 Granted............................................. 780,363 17.77 8.11 Exercised........................................... (212,648) 1.05 Forfeited........................................... (56,155) 7.66 ----------- Outstanding, December 31, 1998............................... 1,605,570 10.53 ----------- Granted............................................. 476,555 15.54 6.44 Exercised........................................... (117,269) 6.93 Forfeited........................................... (83,116) 13.53 ----------- Outstanding, December 31, 1999............................... 1,881,740 11.89 =========== </TABLE> The weighted average exercise price and weighted average fair value of options granted in 1999 whose exercise price is equal to the market price on the date of grant is $14.61 and $6.68, respectively. The weighted average exercise price and weighted average fair value of options granted in 1999 whose exercise price is greater than the market price on the date of grant is $17.50 and $5.92, respectively. The following table summarizes the status of outstanding stock options as of December 31, 1999: <TABLE> <CAPTION> Options Outstanding Options Exercisable ----------------------------------------------- ---------------------------- Weighted Average Weighted Weighted Exercise No. of Remaining Average No. of Average Price Range Shares Life (Years) Exercise Price Shares Exercise Price ----------- ------ ------------ -------------- ------ -------------- <S> <C> <C> <C> <C> <C> $.76 278,798 4.64 $ .76 272,244 $ .76 $.76 - $3.81 177,485 6.61 3.12 170,931 3.10 $5.72 222,994 6.53 5.72 167,930 5.72 $13.38 275,525 9.73 13.38 0 0 $17.50 804,188 7.34 17.50 240,042 17.50 $17.75 - $19.38 65,250 8.47 18.68 11,375 18.47 $19.75 5,000 8.61 19.75 1,250 19.75 $22.00 27,500 9.03 22.00 0 0 $24.75 20,000 8.63 24.75 5,000 24.75 $30.50 5,000 9.98 30.50 0 0 ----------- ---------- --------- ----------- ------------ ------- $.76 - $30.50 1,881,740 7.21 $ 11.89 868,772 $ 7.20 =============== ========== ========= =========== ============ ======= </TABLE> The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". Accordingly, compensation expense for options awarded under the Plans in 1999, 1998 and 1997, has been recognized using the intrinsic value method. The fair value of options granted prior to the consummation of the Offering was estimated using the minimum value method and risk-free interest rates and expected option lives of 6% and seven years, respectively. The minimum value pricing method was designed to value stock options of non-public companies; accordingly, the minimum value method assumed zero volatility. F-13
The Black-Scholes model was used to value options granted subsequent to the Offering using a volatility factor of 50%, estimated option lives of four years, and a risk-free interest rate of 6% for 1999 and 1998. Management believes that the assumptions used and the models applied to value the awards yield a reasonable estimate of the fair value of the grants made under the circumstances, given the alternatives under SFAS No. 123. Effective upon the consummation of the Offering, certain restrictions as to the exercise of options granted under the Company's 1993 Plan expired. Prior to the consummation of the Offering, the Company recorded compensation expense for certain options granted at prices less than their fair market value ratably over seven years from the dates granted, because such options were not exercisable except upon the occurrence of certain events, including a public offering of the Company's Common Stock. Effective upon the consummation of the Offering, the Company recorded a one-time charge for stock-option compensation expense of approximately $870, relating to the acceleration of the vesting period of certain of the Company's stock options from seven to four years. Compensation expense charged to operations using the intrinsic value method totaled $162, $1,297 (including the one-time charge of $870 referred to above), and $873 for the years ended December 31, 1999, 1998, and 1997, respectively. Had the Company recorded compensation expense using the fair value method under SFAS No. 123, pro forma net income and diluted net income per share for the years ended December 31 would have been as follows: <TABLE> <CAPTION> Pro Forma --------------- 1999 1998 1997 ---- ---- ---- <S> <C> <C> <C> Net income, as reported $ 22,730 $ 15,272 $ 10,890 Net income, under SFAS No. 123 21,511 14,423 10,824 Diluted net income per share, as reported 1.41 .98 .76 Diluted net income, under SFAS No. 123 1.33 .93 .76 </TABLE> 1997 Employee Stock Purchase Plan In November 1997, the Board adopted and the stockholders approved the 1997 Employee Stock Purchase Plan (the "Purchase Plan"), which became effective on February 1, 1999. The Purchase Plan authorizes the issuance of Common Stock to participating employees. Under the terms of the Purchase Plan, the purchase 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. 9. INCOME TAXES The provision for income taxes prior to March 6, 1998 was based on the state income tax obligations of the Company as an S Corporation and was $639 for the year ended December 31, 1997. Effective with the consummation of the Offering, the Company's S Corporation election was terminated and the Company began to account for income taxes as a C Corporation. The 1999 and 1998 provision for income taxes and unaudited 1998 and 1997 pro forma provision for income taxes consisted of the following: <TABLE> <CAPTION> Years Ended December 31, ------------------------ (Pro Forma) (Pro Forma) 1999 1998 1998 1997 -------- -------- -------- -------- <S> <C> <C> <C> <C> Paid or currently payable: Federal ................................................. $ 10,373 $ 6,390 $ 7,706 $ 9,214 State ................................................... 1,409 842 766 793 -------- -------- -------- -------- Total current ........................................ 11,782 7,232 8,472 10,007 -------- -------- -------- -------- Deferred: Recognition of deferred tax asset upon termination of S Corporation election ............................... -- (4,200) -- -- Federal ................................................. 1,983 795 1,054 (2,890) State ................................................... 170 78 105 (154) -------- -------- -------- -------- Net deferred ......................................... 2,153 (3,327) 1,159 (3,044) -------- -------- -------- -------- Net provision ........................................ $ 13,935 $ 3,905 $ 9,631 $ 6,963 ======== ======== ======== ======== </TABLE> F-14
The components of the deferred taxes at December 31, 1999 and 1998 are as follows: <TABLE> <CAPTION> 1999 1998 ------- ------- <S> <C> <C> Current: Provisions for doubtful accounts ........................... $ 1,456 $ 2,197 Inventory costs capitalized for tax purposes ............... 519 517 Inventory and sales returns reserves ....................... 1,221 1,365 Deductible expenses, primarily employee-benefit related .... 114 421 Other liabilities .......................................... (1,319) (1,319) ------- ------- Net deferred tax assets ................................. 1,991 3,181 ------- ------- Non-Current: Compensation under non-statutory stock option agreements ... 670 709 Accumulated depreciation ................................... (2,249) (395) ------- ------- Net deferred tax asset (liability) ...................... (1,579) 314 ------- ------- Net deferred tax asset ..................................... $ 412 $ 3,495 ======= ======= </TABLE> The reconciliation of the Company's 1999 and 1998 income tax provision and its 1998 and 1997 unaudited pro forma income tax provision to the statutory federal tax rate is as follows: <TABLE> <CAPTION> (Pro Forma) (Pro Forma) 1999 1998 1998 1997 ---- ---- ---- ---- <S> <C> <C> <C> <C> Statutory tax rate .............................................. 35.0% 35.0% 35.0% 35.0% Recognition of deferred tax asset upon termination of S Corporation election ...................................... -- (18.6) -- -- 1998 S Corporation income not subject to federal income taxes ... -- (2.8) -- -- State income taxes, net of federal benefit ...................... 2.6 2.6 2.6 2.6 Nondeductible expenses .......................................... 0.2 0.2 0.2 0.2 Other - net ..................................................... 0.2 0.9 0.9 1.2 ---- ---- ---- ---- Effective income tax rate .................................... 38.0% 17.3% 38.7% 39.0% ==== ==== ==== ==== </TABLE> 10. EMPLOYEE BENEFIT PLAN The Company has a contributory profit-sharing and employee savings plan covering all qualified employees. No contributions to the profit-sharing element of the plan were made by the Company in 1999, 1998 or 1997. The Company made matching contributions to the employee savings element of the plan of approximately $317 thousand, $361 thousand, and $171 thousand in 1999, 1998 and 1997, respectively. 11. 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 its principal stockholders on a month-to-month basis. In addition, the Company leases office, warehouse facilities and equipment from unrelated parties with remaining terms of one to four years. Future aggregate minimum annual lease payments under these leases at December 31, 1999 are as follows: Year Ending December 31 Related Parties Others Total ----------------------- --------------- ------ ----- 2000.......................... $ 151 $ 2,490 $ 2,641 2001.......................... 151 1,700 1,851 2002.......................... 121 1,471 1,592 2003.......................... 106 155 261 2004.......................... 106 -- 106 2004 and thereafter........... 371 -- 371 Total rent expense aggregated $1,470, $1,521 and $1,398 for the years ended December 31, 1999, 1998 and 1997, respectively, under the terms of the leases described above. Such amounts included $189, $327 and $311 in 1999, 1998 and 1997, respectively, paid to related parties. F-15
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. 12. 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 ---------------------- 1999 1998 1997 ------- ------- ------- <S> <C> <C> <C> Revenue: Sales of various products ........................ $ 1 $ 13 $ 38 Sales of services to affiliated companies ........ 332 -- -- Sales of property and equipment: Net book value ................................ -- -- (14) Proceeds ...................................... -- -- 16 Costs: Purchase of services from affiliated companies ... 6 2 1,280 </TABLE> 13. 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 (Inbound Telesales, Corporate Outbound, 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: Year Ended December 31, ----------------------- 1999 1998 1997 ---------- ---------- ---------- Platform PC and Multi Platform $ 895,412 $ 587,100 $ 439,286 Mac 161,292 145,270 111,289 ---------- ---------- ---------- Total $1,056,704 $ 732,370 $ 550,575 ========== ========== ========== Sales Channel Corporate Outbound $ 694,924 $ 390,922 $ 257,215 Inbound Telesales 303,707 312,356 288,113 On-Line Internet 58,073 29,092 5,247 ---------- ---------- ---------- Total $1,056,704 $ 732,370 $ 550,575 ========== ========== ========== Product Mix Computer Systems and Memory $ 502,530 $ 319,759 $ 232,343 Peripherals 356,216 252,966 188,847 Software 129,944 102,451 86,991 Networking and Communications 68,014 57,194 42,394 ---------- ---------- ---------- Total $1,056,704 $ 732,370 $ 550,575 ========== ========== ========== Substantially, all of the Company's net sales in 1999, 1998 and 1997 were made to customers located in the United States. Shipments to customers located in foreign countries aggregated less than 2% in 1999, 1998 and 1997. All of the Company's assets at December 31, 1999 and 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 other than federal government accounted for more than 1% of total net sales in 1999. Net sales to the federal government in 1999 were $81.4 million or 7.7% of total net sales. No single customer (including the federal government) accounted for more than 1% of total net sales in 1998 and 1997. F-16
14. SELECTED UNAUDITED QUARTERLY FINANCIAL RESULTS The following table sets forth certain unaudited quarterly data of the Company for each of the quarters since January 1998. This information has been prepared on the same basis as the annual 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 annual financial statements and the notes thereto included elsewhere in this document. The quarterly operating results are not necessarily indicative of future results of operations. See "Factors That May Affect Future Results and Financial Condition - Historical Net Losses; Variability of Quarterly Results." <TABLE> <CAPTION> Quarters Ended --------------------------------------------------------- March 31, June 30, Sept. 30, Dec. 31, 1999 1999 1999 1999 --------------------------------------------------------- (in thousands, except per share data) <S> <C> <C> <C> <C> Net sales $ 224,979 $ 231,833 $ 282,103 $ 317,789 Cost of sales 197,913 204,034 247,651 277,760 --------- ---------- ---------- ---------- Gross profit 27,066 27,799 34,452 40,029 Selling, general and administrative expenses 19,763 20,040 24,333 27,269 --------- ---------- ---------- ---------- Income from operations 7,303 7,759 10,119 12,760 Interest expense (266) (276) (449) (401) Other, net 94 47 32 (57) --------- ---------- ---------- ---------- Income before income taxes 7,131 7,530 9,702 12,302 Income tax provision (1) (2,710) (2,862) (3,687) (4,676) --------- ---------- ---------- ---------- Net Income $ 4,421 $ 4,668 $ 6,015 $ 7,626 ========= ========== ========== ========== Weighted average common shares outstanding: Basic $ 15,622 15,627 15,651 15,697 ========= ========== ========== ========== Diluted $ 16,068 16,061 16,078 16,455 ========= ========== ========== ========== Earnings per common share: Basic $ .28 $ .30 $ .39 $ .48 ========= ========== ========== ========== Diluted $ .28 $ .29 $ .37 $ .47 ========= ========== ========== ========== </TABLE> F-17
<TABLE> <CAPTION> Quarters Ended --------------------------------------------------------- March 31, June 30, Sept. 30, Dec. 31, 1998 1998 1998 1998 --------------------------------------------------------- (in thousands, except per share data) <S> <C> <C> <C> <C> Net sales $ 168,643 $ 174,349 $ 169,089 $ 220,289 Cost of sales 146,694 151,768 147,837 192,797 --------- ---------- ---------- ---------- Gross profit 21,949 22,581 21,252 27,492 Selling, general and administrative expenses 16,858 16,042 16,317 19,304 Additional stockholder/officer compensation 2,354 -- -- -- --------- ---------- --------- --------- Income from operations 2,737 6,539 4,935 8,188 Interest expense (206) (51) (10) (148) Other, net 86 213 233 33 --------- ---------- ---------- ---------- Income before income taxes 2,617 6,701 5,158 8,073 Income tax benefit (provision) (1) 3,788 (2,613) (2,012) (3,068) --------- ---------- ---------- ----------- Net Income $ 6,405 $ 4,088 $ 3,146 $ 5,005 ========= ========== ========== ========== Weighted average common shares outstanding: Basic 15,414 15,443 15,548 ========== ========== ========== Diluted 15,938 16,000 15,963 ========== ========== ========== Earnings per common share: Basic $ .27 $ .20 $ .33 ========== ========== ========== Diluted $ .26 $ .20 $ .32 ========== ========== ========== Pro forma data: Historical income before income taxes $ 2,617 Pro forma adjustment--stockholder/officer compensation in excess of the aggregate base salaries 2,354 --------- Pro forma income before taxes 4,971 Pro forma income taxes 1,938 --------- Pro forma net income (2) $ 3,033 ========= Pro forma weighted average shares outstanding: Basic 14,236 ========= Diluted 14,835 ========= Pro forma earnings per share: Basic $ .21 ========= Diluted $ .20 ========= </TABLE> (1) For all periods prior to March 6, 1998 described herein, the Company elected to be treated as an S Corporation under Subchapter S of the Code, and applicable state laws. Effective March 6, 1998, the closing of the Company's initial public offering, the Company's S Corporation election was automatically terminated, and the Company became subject to federal and state income taxes as a C Corporation from that date forward. For the quarter ended March 31, 1998, the income tax provision includes a $4.2 million 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. (2) Pro forma net income is determined by (i) eliminating stockholder/officer compensation in excess of the aggregate base salaries ($600,000) per year and (ii) by eliminating the actual income tax provision and adding a provision for Federal and state income taxes that would have been payable by the Company if taxed under Subchapter C of the Code for all periods prior to March 6, 1998. F-18
15. SUBSEQUENT EVENTS On January 1, 2000, the Company announced a new holding company structure to support PC Connection's future growth and plans to expand its current business lines through internal growth and potential acquisitions. Outstanding shares of common stock representing interests in PC Connection prior to the holding company formation were converted into shares of the new holding company on a one-for-one basis through a non-taxable transaction. Common stock shares of the new holding company were listed on the Nasdaq National Market under the symbol, "PCCC", the same exchange and symbol used by the predecessor company. The new shares hold the same voting power that shares of the predecessor company held. No additional capital stock was issued as part of the transaction. The directors and officers of the predecessor company serve as the directors and officers of the new holding company. On January 4, 2000, the Company acquired Merisel Americas, Inc. call Center operation in Marlborough, Massachusetts for approximately $2.2 million. PC Connection offered employment opportunities to more than 100 of Merisel's highly-trained telesales account managers and support staff to join PC Connection's corporate outbound sales organization. Substantially, all such employees accepted employment with PC Connection. F-19
PC CONNECTION, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (amounts in thousands) <TABLE> <CAPTION> Balance at Charged to Balance at Beginning Costs and Deductions- End of Description of Period Expenses Write-Offs Period ----------- --------- -------- ---------- ------ <S> <C> <C> <C> <C> Allowance for Sales Returns Year Ended December 31, 1997...................... $ 867 $ 1,834 $ -- $ 2,701 Year Ended December 31, 1998...................... 2,701 1,329 -- 4,030 Year Ended December 31, 1999...................... 4,030 (313) -- 3,717 Allowance for Doubtful Accounts Year Ended December 31, 1997...................... 1,284 3,339 (1,964) 2,659 Year Ended December 31, 1998...................... 2,659 6,296 (3,834) 5,121 Year Ended December 31, 1999...................... 5,121 6,821 (8,009) 3,933 Inventory Valuation Reserve Year Ended December 31, 1997...................... 1,705 3,315 (3,124) 1,896 Year Ended December 31, 1998...................... 1,896 6,017 (5,323) 2,590 Year Ended December 31, 1999...................... 2,590 5,350 (6,099) 1,841 </TABLE> S-1