================================================================================ 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, 2001 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 02-0513618 -------- ---------- (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 August 2, 2001 was 24,517,854. ================================================================================
PC CONNECTION, INC. AND SUBSIDIARIES FORM 10-Q TABLE OF CONTENTS <TABLE> <CAPTION> PART I FINANCIAL INFORMATION Page --------------------- <S> <C> <C> Item 1 Financial Statements: Independent Accountants' Report ................................................... 1 Condensed Consolidated Balance Sheets - June 30, 2001 and December 31, 2000 .......................................................... 2 Condensed Consolidated Statements of Income - Three months ended June 30, 2001 and 2000; Six months ended June 30, 2001 and 2000 ........................................ 3 Condensed Consolidated Statement of Changes in Stockholders' Equity - Six months ended June 30, 2001 ................................................. 4 Condensed Consolidated Statements of Cash Flows - Six months ended June 30, 2001 and 2000 ........................................ 5 Notes to Condensed Consolidated Financial Statements ............................. 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ............................................ 10 Item 3 Quantitative and Qualitative Disclosures About Market Risk ........................ 15 PART II OTHER INFORMATION ----------------- Item 1 Legal Proceedings ................................................................. 16 Item 2 Changes in Securities and Use of Proceeds ......................................... 16 Item 3 Defaults Upon Senior Securities ................................................... 16 Item 4 Submission of Matters to a Vote of Security Holders ............................... 16 Item 5 Other Information ................................................................. 17 Item 6 Exhibits and Reports on Form 8-K .................................................. 17 SIGNATURES ........................................................................ 18 ---------- </TABLE>
INDEPENDENT ACCOUNTANTS' REPORT To the Board of Directors and Stockholders of PC Connection, Inc. and Subsidiaries Merrimack, New Hampshire We have reviewed the accompanying condensed consolidated balance sheet of PC Connection, Inc. and subsidiaries (the "Company") as of June 30, 2001, and the related condensed consolidated statements of income, changes in stockholders' equity and cash flows for the three-month and six-month periods included on Form 10-Q for the quarterly period ended June 30, 2001. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of PC Connection, Inc. and subsidiaries as of December 31, 2000, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated January 25, 2001, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Boston, Massachusetts July 18, 2001 -1-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements CONDENSED CONSOLIDATED BALANCE SHEETS (amounts in thousands) <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------------ June 30, December 31, - ------------------------------------------------------------------------------------------------------------------------------------ 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ (unaudited) <S> <C> <C> ASSETS Current Assets: Cash and cash equivalents $ 43,376 $ 7,363 Accounts receivable, net 113,327 139,644 Inventories--merchandise 44,993 54,679 Deferred income taxes 2,542 2,175 Income tax receivable 341 4,882 Prepaid expenses and other current assets 2,549 3,064 ---------- ---------- Total current assets 207,128 211,807 Property and equipment, net 29,359 28,665 Goodwill, net 9,158 9,509 Other assets 800 432 ---------- ---------- Total assets $ 246,445 $ 250,413 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current maturities of capital lease obligation to affiliate $ 162 $ 153 Current maturities of long-term debt 2,000 1,000 Accounts payable 81,473 86,216 Accrued expenses and other liabilities 8,683 12,769 ---------- ---------- Total current liabilities 92,318 100,138 Long-term debt, less current maturities - 1,000 Capital lease obligation to affiliate, less current maturities 6,709 6,792 Deferred taxes 3,842 3,555 Other liabilities 152 241 ---------- ---------- Total liabilities 103,021 111,726 ---------- ---------- Stockholders' Equity: Common stock 245 244 Additional paid-in capital 72,409 71,542 Retained earnings 70,770 66,901 ---------- ---------- Total stockholders' equity 143,424 138,687 ---------- ---------- Total liabilities and stockholders' equity $ 246,445 $ 250,413 ========== ========== </TABLE> See accompanying notes to condensed consolidated financial statements. -2-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (amounts in thousands, except per share data) <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------------ Three Months Six Months Ended Ended June 30, June 30, - ------------------------------------------------------------------------------------------------------------------------------------ 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Net sales $ 297,338 $ 366,090 $ 599,113 $ 699,889 Cost of sales 264,486 321,145 530,936 614,314 ----------- ----------- ----------- ----------- Gross profit 32,852 44,945 68,177 85,575 Selling, general and administrative expenses 30,653 30,903 61,116 59,910 Non-recurring charge - - 851 - ----------- ----------- ----------- ----------- Income from operations 2,199 14,042 6,210 25,665 Interest expense (277) (334) (654) (674) Other, net 396 165 684 369 ----------- ---------- ----------- ----------- Income before taxes 2,318 13,873 6,240 25,360 Income taxes (882) (5,272) (2,371) (9,640) ----------- ---------- ----------- ----------- Net income $ 1,436 $ 8,601 $ 3,869 $ 15,720 =========== ========== =========== =========== Earnings per common share: Basic $ 0.06 $ 0.36 $ 0.16 $ 0.66 =========== ========== =========== ============ Diluted $ 0.06 $ 0.34 $ 0.16 $ 0.62 =========== ========== =========== ============ </TABLE> See accompanying notes to condensed consolidated financial statements. -3-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements CONDENSED 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, 2000 24,416 $ 244 $ 71,542 $ 66,901 $ 138,687 Exercise of stock options, including income tax benefits 11 - 140 - 140 Issuance of stock under employee stock purchase plan 86 1 727 - 728 Net income - - - 3,869 3,869 --------- --------- ---------- ---------- ---------- Balance, June 30, 2001 24,513 $ 245 $ 72,409 $ 70,770 $ 143,424 ========= ========= ========== ========== ========== </TABLE> See accompanying notes to condensed consolidated financial statements. -4-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (amounts in thousands) <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------------ Six Months Ended June 30, - ------------------------------------------------------------------------------------------------------------------------------------ 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Operating Activities: <S> <C> <C> Net income $ 3,869 $ 15,720 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,909 3,036 Deferred income taxes (80) (381) Compensation under nonstatutory stock option agreements - 51 Provision for doubtful accounts 5,346 4,443 (Gain)/loss on disposal of fixed assets (77) 24 Changes in assets and liabilities: Accounts receivable 20,971 (38,557) Inventories 9,686 (5,277) Prepaid expenses and other current assets 5,056 (3,591) Other non-current assets (382) (361) Income tax benefits from exercise of stock options 8 2,960 Accounts payable (4,768) 26,227 Accrued expenses and other liabilities (4,086) (25) ---------- ---------- Net cash provided by operating activities 39,452 4,269 ---------- ---------- Cash Flows from Investing Activities: Purchases of property and equipment (4,237) (5,233) Proceeds from sale of property and equipment 12 74 Payment for acquisitions, net of cash acquired - (2,158) ---------- ---------- Net cash used for investing activities (4,225) (7,317) ---------- ---------- Cash Flows from Financing Activities: Proceeds from short-term borrowings 47,020 167,961 Repayment of short-term borrowings (47,020) (167,961) Repayment of notes payable - (1,000) Repayment of capital lease obligation to affiliate (74) (36) Issuance of stock upon exercise of nonstatutory stock options 132 2,406 Issuance of stock under employee stock purchase plan 728 479 ---------- ---------- Net cash provided by financing activities 786 1,849 ---------- ---------- Increase/(decrease) in cash and cash equivalents 36,013 (1,199) Cash and cash equivalents, beginning of period 7,363 20,416 ---------- ---------- Cash and cash equivalents, end of period $ 43,376 $ 19,217 ========== ========== Supplemental Cash Flow Information: Interest paid $ 633 $ 293 Income taxes paid 295 10,957 </TABLE> See accompanying notes to condensed consolidated financial statements. -5-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) - -------------------------------------------------------------------------------- Note 1-Basis of Presentation - -------------------------------------------------------------------------------- The accompanying condensed consolidated financial statements of PC Connection, Inc. and Subsidiaries ("PCC" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America. 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, 2000 filed with the Securities and Exchange Commission ("SEC"). The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements contained in the Company's Annual Report on Form 10-K. In the opinion of management, the accompanying unaudited condensed 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, 2001 may not be indicative of the results expected for any succeeding quarter or the entire year ending December 31, 2001. Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. This includes a reclassification made to the income statements for the three and six months ended June 30, 2000 to effect the December 2000 adoption by the Company of Emerging Issues Task Force Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." The Consensus specifically stated that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenues earned for the goods provided and should be classified as revenue. It was previously the Company's policy to record such revenues as a reduction of cost of goods sold. All net sales amounts and gross margin percentages reflect the reclassification of amounts billed to customers in sales transactions related to shipping and handling as revenue. The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective January 1, 2001. The adoption of SFAS No. 133 did not have any impact on either the financial position or results of operations of the Company. Revenue Recognition Revenue on product sales is recognized at the point in time when persuasive evidence of an arrangement exists, the price is fixed and final, delivery has occurred and there is a reasonable assurance of collection of the sales proceeds. The Company generally obtains oral or written purchase authorizations from its customers for a specified amount of product at a specified price and considers delivery to have occurred at the point of shipment. The Company provides its customers with a limited thirty day right of return only for defective merchandise. Revenue is recognized at shipment and a reserve for sales returns is recorded. The Company has demonstrated the ability to make reasonable and reliable estimates of product returns in accordance with SFAS No. 48 based on significant historical experience. 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. Provisions are made currently for obsolete, slow moving and nonsalable inventory. - -------------------------------------------------------------------------------- Note 2-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 options outstanding to purchase common stock. -6-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (Unaudited) - -------------------------------------------------------------------------------- Note 2-Earnings Per Share - Cont'd. - -------------------------------------------------------------------------------- The following table sets forth the computation of basic and diluted earnings per share: <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------------ Three Months Six Months Ended Ended - ------------------------------------------------------------------------------------------------------------------------------------ June 30, (amounts in thousands, except per share data) 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Numerator: Net income $ 1,436 $ 8,601 $ 3,869 $ 15,720 ======== ======= ======== ========= Denominator: Denominator for basic earnings per share: Weighted average shares 24,422 23,926 24,419 23,801 Dilutive effect of unexercised employee stock options: 572 1,630 546 1,505 -------- ------- -------- --------- Denominator for diluted earnings per share 24,994 25,556 24,965 25,306 ======== ======= ======= ========= Earnings per share: Basic $ .06 $ .36 $ .16 $ .66 ======== ======= ======= ========= Diluted $ .06 $ .34 $ .16 $ .62 ======== ======= ======= ========= </TABLE> The following unexercised stock options were excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2001 and 2000 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) 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Anti-dilutive stock options 598 -- 608 3 ======== ======= ======= ======= </TABLE> - -------------------------------------------------------------------------------- Note 3-Reporting Comprehensive Income - -------------------------------------------------------------------------------- The Company has no other comprehensive income in any of the periods presented. Accordingly, a separate statement of comprehensive income is not presented. - -------------------------------------------------------------------------------- Note 4-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 (Notebooks, Desktops and Servers, Storage Devices, Software, Networking Communications, Printers, Video and Monitors, Memory, and Accessories and Other). -7-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (Unaudited) - -------------------------------------------------------------------------------- Note 4-Segment and Related Disclosures - Cont'd. - -------------------------------------------------------------------------------- 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) 2001 2000 2001 2000 - ----------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Platform -------- PC and Multi Platform $ 265,460 $ 327,197 $ 538,884 $ 620,832 Mac 31,878 38,893 60,229 79,057 --------- ---------- ---------- ---------- Total $ 297,338 $ 366,090 $ 599,113 $ 699,889 ========= ========== ========== ========== Sales Channel ------------- Corporate Outbound $ 234,026 $ 280,841 $ 467,361 $ 521,560 Inbound Telesales 37,234 59,707 77,276 127,640 On-Line Internet 26,078 25,542 54,476 50,689 --------- ---------- ---------- ---------- Total $ 297,338 $ 366,090 $ 599,113 $ 699,889 ========= ========== ========== ========== Product Mix ----------- Notebooks $ 58,846 $ 96,068 $ 129,567 $ 186,983 Desktop/Servers 37,710 53,134 76,539 101,839 Storage Devices 29,175 32,458 59,139 62,153 Software 39,457 40,200 76,475 76,089 Networking Communications 27,613 28,943 54,598 52,896 Printers 26,142 24,523 50,052 49,088 Videos & Monitors 29,200 29,007 53,808 53,934 Memory 9,180 14,517 19,272 26,791 Accessories/Other 40,015 47,240 79,663 90,116 --------- ---------- ---------- ---------- Total $ 297,338 $ 366,090 $ 599,113 $ 699,889 ========= ========== ========== ========== </TABLE> Substantially, all of the Company's net sales for the three and six months ended June 30, 2001 and 2000 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, 2001 and December 31, 2000 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. Except for the federal government, no single customer accounted for more than 3% of total net sales in the three and six months ended June 30, 2001 and 2000. Sales to the federal government accounted for $27.3 million, or 9.2% of total net sales for the quarter ended June 30, 2001 and $29.0 million, or 7.9% of total net sales for the quarter ended June 30, 2000. Sales to the federal government accounted for $51.4 million, or 8.6% of total net sales for the six months ended June 30, 2001 and $53.7 million or 7.7% of total net sales for the six months ended June 30, 2000. - -------------------------------------------------------------------------------- Note 5-Non-recurring Charge - -------------------------------------------------------------------------------- On March 28, 2001, the Company announced the planned reduction of non-sales staff by approximately 125 individuals, or 7.5% of the Company's work force. The Company took a one-time charge of approximately $851,000 in the first quarter to cover costs related to this staff reduction. This is reflected under the caption, "non-recurring charge" on the condensed consolidated statements of income for the six months ended June 30, 2001. This staff reduction was completed in early April 2001. -8-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 1 - Financial Statements NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED (Unaudited) - -------------------------------------------------------------------------------- Note 6-Share Repurchase Authorization - -------------------------------------------------------------------------------- The Company announced on March 28, 2001 that its Board of Directors authorized the spending of up to $15.0 million to repurchase the Company's common stock. Share purchases will be made in the open market from time to time depending on market conditions. No shares had been repurchased as of the end of the quarter ended June 30, 2001. - -------------------------------------------------------------------------------- Note 7-Potential Acquisition - -------------------------------------------------------------------------------- On May 30, 2001, the Company announced that it had entered into a Merger Agreement, dated as of May 29, 2001 (the "Merger Agreement"), with Cyberian Outpost, Inc., an Internet provider of consumer technology and e-business services. Under the terms of the Merger Agreement, the Company would issue to Cyberian Outpost's stockholders shares of the Company's common stock based upon an exchange ratio which will vary with Cyberian Outpost's revenue for the three-month period ending August 2001 and the average closing price of the Company's Common Stock for the ten trading days ending on the four days prior to closing. The boards of directors of both companies had unanimously approved the transaction. The merger is subject to approval of the Cyberian Outpost stockholders and to other closing conditions. Cyberian Outpost also issued a warrant giving the Company the right to buy from Cyberian Outpost shares of common stock, which represented approximately 19.9% of the shares of Cyberian Outpost common stock outstanding on May 29, 2001 at an exercise price of $0.51 per share. The Company cannot exercise the warrant unless certain triggering events occur. If certain corporate transactions involving Cyberian Outpost occur, the Company may require Cyberian Outpost to repurchase the warrant for a price between $1.0 million and $1.5 million. In connection with the Merger Agreement, the Company entered into a credit and supply agreement with Cyberian Outpost to provide Cyberian Outpost with working capital loans of up to $3.0 million and an inventory line of up to $5.0 million, each of which is secured by Cyberian Outpost's assets. The transaction was structured as a stock-for-stock, tax-free merger and will be accounted for under the purchase method of accounting if approved. - -------------------------------------------------------------------------------- Note 8 - Recent Accounting Pronouncements - -------------------------------------------------------------------------------- In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. -9-
PC CONNECTION, INC. AND SUBSIDIARIES 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, 2000 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, competitive risks, pricing risks, and the overall level of economic activity and the level of business investment in information technology products. 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 selected computer publications 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) the Company's Internet web site. The Company offers both PC compatible products and Mac compatible products. Reliance on Mac product sales has decreased over the last four years, from 23.0% of net sales for the year ended December 31, 1996 to 10.1% of net sales for the six months ended June 30, 2001. The Company believes that such sales will continue to decrease as a percentage of net sales and may decline in absolute dollar volume in 2001 and future periods. The weakness in demand for technology products experienced by the Company in the fourth quarter of 2000 and the first quarter of 2001 continued through the second quarter of 2001, resulting in overall conservative buying patterns, order deferrals and longer sales cycles. - -------------------------------------------------------------------------------- Recent Developments - -------------------------------------------------------------------------------- On May 30, 2001, the Company announced that it had entered into a Merger Agreement, dated as of May 29, 2001 (the "Merger Agreement"), with Cyberian Outpost, Inc., an Internet provider of consumer technology and e-business services. Under the terms of the Merger Agreement, the Company would issue to Cyberian Outpost's stockholders shares of the Company's common stock, based upon an exchange ratio which will vary with Cyberian Outpost's revenue for the three-month period ending August 2001 and the average closing price of the Company's Common Stock for the ten trading days ending on the four days prior to closing. The boards of directors of both companies have unanimously approved the transaction. The merger is subject to approval of the Cyberian Outpost stockholders and to other closing conditions. Cyberian Outpost also issued a warrant giving the Company the right to buy from Cyberian Outpost shares of common stock, which represented approximately 19.9% of the shares of Cyberian Outpost common stock outstanding on May 29, 2001 at an exercise price of $0.51 per share. The Company cannot exercise the warrant unless certain triggering events occur. If certain corporate transactions involving Cyberian Outpost occur, the Company may require Cyberian Outpost to repurchase the warrant for a price between $1.0 million and $1.5 million. -10-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-CONTINUED - -------------------------------------------------------------------------------- Recent Developments - Cont'd. - -------------------------------------------------------------------------------- In connection with the Merger Agreement, the Company entered into a credit and supply agreement with Cyberian Outpost to provide Cyberian Outpost with working capital loans of up to $3.0 million and an inventory line of up to $5.0 million, each of which is secured by Cyberian Outpost's assets. The transaction was structured as a stock-for-stock, tax-free merger and will be accounted for under the purchase method of accounting, if approved. - -------------------------------------------------------------------------------- Results of Operations - -------------------------------------------------------------------------------- Three Months and Six Months Ended June 30, 2001 Compared with the Three Months and Six Months Ended June 30, 2000 The following table sets forth for the periods indicated information derived from the Company's statements of income expressed as a percentage of net sales. <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------------------- June 30, 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net sales (in millions) ........................ $ 297.3 $ 366.1 $ 599.1 $ 699.9 Net sales ...................................... 100.0% 100.0% 100.0% 100.0% Gross profit ................................... 11.0 12.3 11.4 12.2 Selling, general and administrative expenses ... 10.3 8.4 10.2 8.6 Non-recurring charge ........................... - - 0.1 - Income from operations ......................... 0.7 3.8 1.0 3.7 Interest expense ............................... (0.1) (0.1) (0.1) (0.1) Other, net ..................................... 0.1 - 0.1 0.1 Income before income taxes ..................... 0.8 3.8 1.0 3.6 Income taxes ................................... (0.3) (1.4) (0.4) (1.4) Net income ..................................... 0.5 2.3 0.6 2.2 </TABLE> -11-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-CONTINUED - -------------------------------------------------------------------------------- Results of Operations - General - Cont'd. - -------------------------------------------------------------------------------- The following table sets forth the Company's percentage of net sales by platform, sales channel, and product mix: <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------- Three Months Ended Six Months Ended - ------------------------------------------------------------------------------------------------------------------------------- June 30, 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Platform PC and Multi-Platform 89% 89% 90% 89% Mac 11 11 10 11 ---- ---- ----- ---- Total 100% 100% 100% 100% ==== ==== ===== ==== Sales Channel Corporate Outbound 79% 77% 78% 75% Inbound Telesales 12 16 13 18 On-Line Internet 9 7 9 7 ---- ---- ----- ---- Total 100% 100% 100% 100% ==== ==== ===== === Product Mix Notebooks 20% 26% 22% 27% Desktop/Servers 13 14 13 14 Storage Devices 10 9 10 9 Software 13 11 13 11 Networking Communications 9 8 9 7 Printers 9 7 8 7 Videos & Monitors 10 8 9 8 Memory 3 4 3 4 Accessories/Other 13 13 13 13 ---- ---- ----- ---- Total 100% 100% 100% 100% ==== ==== ===== ==== </TABLE> Net sales decreased $68.8 million, or 18.8%, to $297.3 million for the quarter ended June 30, 2001 from $366.1 million for the comparable period in 2000 due to the weakness in demand for information technology products. Net sales for the six months ended June 30, 2001 decreased $100.8 million, or 14.4%, to $599.1 million from $699.9 million for the comparable period in 2000. Outbound sales decreased $46.8 million, or 16.7%, to $234.0 million in the three months ended June 30, 2001 from $280.8 million in the three months ended June 30, 2000. Outbound sales decreased $54.2 million, or 10.4%, to $467.4 million for the six months ended June 30, 2001 from $521.6 million in the comparable period in 2000. Inbound sales, which primarily serve the Company's consumer and very small business customers, decreased $22.5 million, or 37.7%, to $37.2 million in the quarter ended June 30, 2001 from $59.7 million in the comparable period in 2000; and decreased $50.3 million, or 39.4%, to $77.3 million for the six months ended June 30, 2001 from $127.6 million in the comparable period in 2000. On-line Internet sales increased $0.6 million, or 2.4%, to $26.1 million in the three months ended June 30, 2001 from $25.5 million in the comparable period in 2000 and increased $3.8 million, or 7.5% to $54.5 million for the six months ended June 30, 2001, from $50.7 million in the comparable period in 2000. The Company's sales to consumers and small businesses have been more negatively impacted during the recent spending slow down than have sales to its larger business customers, who generally purchase through either the outbound or Internet channels. All product categories were affected by the recent economic uncertainty, with second quarter 2001 sales of notebooks declining 38.8% to $58.8 million from $96.1 million for the comparable period in 2000. Desktop/server sales declined 29.0% to $37.7 million for the quarter ended June 30, 2001 from $53.1 million for the comparable period in 2000. -12-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-CONTINUED - -------------------------------------------------------------------------------- Results of Operations - General - Cont'd. - -------------------------------------------------------------------------------- Net sales of enterprise server and networking products decreased 14.4% to $55.3 million for the quarter ended June 30, 2001 from $64.6 million for the comparable period in 2000. Enterprise server and networking products represented 18.6% of overall net sales in the second quarter of 2001, up from 17.6% of net sales for the comparable period in 2000. Management believes that while in the comparative periods sales declined, these product categories will eventually grow substantially as its customers further upgrade their networks and communication infrastructures. Future growth will likely depend also on improvement in general economic conditions. Average order size decreased $63, or 5.3%, to $1,120 for the quarter ended June 30, 2001 from $1,183 in the second quarter of 2000. However, sequentially, average order size increased 7.7% from $1,040 reported for the quarter ended March 31, 2001. Gross profit decreased $12.0 million, or 26.7%, to $32.9 million for the quarter ended June 30, 2001 from $44.9 million for the comparable period in 2000. Gross profit for the six months ended June 30, 2001 decreased $17.4 million, or 20.3%, to $68.2 million from $85.6 million for the comparable period in 2000. Gross profit margin as a percentage of net sales decreased to 11.1% in the second quarter of 2001 from 12.3% for the comparable period in 2000. Gross profit margin as a percentage of net sales decreased to 11.4% in the first six months of 2001 from 12.2% for the comparable period in 2000. The gross margin decline resulted primarily from intense competitive pricing and lower overall demand levels during the quarter. The Company's profit margins are also influenced by the relative mix of inbound, outbound, and on-line Internet Sales. 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. The gross profit dollar contribution per outbound sales order is generally higher as average sizes of orders to corporate accounts are usually larger. The Company expects that its gross margin, as a percentage of sales, may vary by quarter based upon vendor support programs, product mix, pricing strategies, market conditions and other factors. Selling, general and administrative expenses decreased $0.2 million, or 0.6%, to $30.7 million for the quarter ended June 30, 2001 from $30.9 million for the comparable quarter in 2000. Selling, general and administrative expenses (SG&A) for the six months ended June 30, 2001 increased by $1.2 million, or 2.0%, to $61.1 million from $59.9 million in the six months ended June 30, 2000. The Company expects that its SG&A, as a percentage of net sales, may vary by quarter depending on changes in sales volume, as well as the levels of continuing investments in key growth initiatives. Non-recurring charge was a one-time charge of $0.9 million, or $0.02 per share, in the first quarter of 2001 related to a staffing reduction. Income from operations decreased $11.8 million, or 84.3%, to $2.2 million for the quarter ended June 30, 2001, from $14.0 million for the comparable period in 2000. Income from operations as a percentage of sales decreased from 3.8% in the three months ended June 30, 2000 to 0.7% for the comparable period in 2001 for the reasons discussed above. Similarly, income from operations for the six months ended June 30, 2001 decreased $19.5 million, or 75.9%, to $6.2 million from $25.7 million for the comparable period in 2000. Income from operations as a percentage of sales decreased from 3.7% for the six months ended June 30, 2000 to 1.0% for the comparable period in 2001. Interest expense decreased $0.05 million, or 15.1%, to $0.28 million for the quarter ended June 30, 2001 from $0.33 million, for the comparable quarter in 2000. Similarly, interest expense for the six months ended June 30, 2001, decreased $0.02 million, or 3.0%, to $0.65 million from $0.67 million for the comparable period in 2000. This decrease in interest expense can be attributed to lower average borrowings outstanding in the respective 2001 periods compared to the 2000 periods. -13-
PC CONNECTION, INC. AND SUBSIDIARIES Part I - Financial Information Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS-CONTINUED - -------------------------------------------------------------------------------- Results of Operations - General - Cont'd. - -------------------------------------------------------------------------------- Other, net, which is essentially comprised of interest income increased $0.23 million, or 135.3% to $0.40 million in the quarter ended June 30, 2001 from $0.17 million, for the comparable period in 2000. Similarly, other, net for the six months ended June 30, 2001 increased $0.31 million, or 83.8%, to $0.68 million from $0.37 million for the comparable period in 2000. This increase was due primarily to higher interest income from investments. Income taxes for the quarter ended June 30, 2001 were $0.9 million compared to $5.3 million for the comparable quarter in 2000. Income taxes for the six months ended June 30, 2001 were $2.4 million, compared to $9.6 million for the comparable period in 2000. The effective tax rate was 38% for all periods. Net income for the quarter ended June 30, 2001 decreased $7.2 million, or 83.7%, to $1.4 million from $8.6 million for the comparable quarter in 2000, principally as a result of the decreases in operating income as described above. Net income decreased $11.8 million, or 75.2%, to $3.9 million for the six months ended June 30, 2001 from $15.7 million for the comparable period in 2000. - -------------------------------------------------------------------------------- Liquidity and Capital Resources - -------------------------------------------------------------------------------- The Company has historically financed its operations and capital expenditures through cash flow from operations and bank borrowings. The Company believes that funds generated from operations, together with available credit under its bank line of credit, will be sufficient to finance its working capital and capital expenditure requirements at least through the next twelve months. The Company's ability to continue funding its planned growth is dependent upon its ability to generate sufficient cash flow from operations or to obtain additional funds through equity or debt financing, or from other sources of financing, as may be required. At June 30, 2001, the Company had cash and cash equivalents of $43.4 million and working capital of $114.8 million. At December 31, 2000, the Company had cash and cash equivalents of $7.4 million and working capital of $111.7 million. The Company has an unsecured credit agreement with a bank providing for short-term borrowings up to $70.0 million, which bears interest at various rates ranging from the prime rate (6.75% at June 30, 2001) to prime less 1%, depending on the ratio of senior debt to EBITDA (earnings before interest, taxes, depreciation and amortization). 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, 2001. Net cash provided by operating activities was $39.5 million for the six months ended June 30, 2001, as compared to $4.3 million provided by operating activities for the comparable period in 2000. 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. Since accounts receivable and inventories have substantially decreased since December 31, 2000, cash levels have increased commensurately. Capital expenditures were $4.2 million in the six months ended June 30, 2001 as compared to $5.2 million for the comparable period in 2000. The majority of the capital expenditures for the respective 2001 and 2000 periods relate to computer hardware and software for the Company's information systems. Total capital expenditures for the year ended December 31, 2001 are estimated to be $8.7 million. - -------------------------------------------------------------------------------- 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. -14-
PC CONNECTION, INC. AND SUBSIDIARIES 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. In addition, the Company's unsecured credit agreement provides for borrowings which bear interest at variable rates based on the prime rate. The Company had no borrowings outstanding pursuant to its credit agreement as of June 30, 2001. 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. -15-
PC CONNECTION, INC. AND SUBSIDIARIES 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 At the 2001 Annual Meeting of Stockholders of the Company (the "Annual Meeting") on May 24, 2001, the following matters were acted upon by the stockholders of the Company: 1. the election of five Directors; 2. the approval of the amendment to the Company's Amended and Restated Certificate of Incorporation increasing the number of authorized shares of the Company's Common Stock from 30,000,000 shares to 100,000,000 shares and the number of authorized shares of Preferred Stock from 7,500,000 shares to 10,000,000 shares; 3. the approval of an amendment to the Company's 1997 Stock Incentive Plan to increase the number of shares of common stock available for grant under the Plan by 600,000; and 4. the ratification of the appointment of Deloitte & Touche LLP as the Company's independent auditors for the current fiscal year. The number of shares of Common Stock issued, outstanding and eligible to vote as of the record date of March 28, 2001 was 24,419,525. The results of the voting on each of the matters presented to stockholders at the Annual Meeting are set forth below: <TABLE> <CAPTION> VOTES VOTES VOTES FOR AGAINST ABSTAINED UNVOTED <S> <C> <C> <C> <C> <C> 1. Election of Directors: Patricia Gallup 22,425,049 979,189 N.A. N.A. David Hall 23,373,842 30,356 N.A. N.A. David B. Beffa-Negrini 22,429,859 974,339 N.A. N.A. Martin C. Murrer 23,378,392 25,806 N.A. N.A. Peter J. Baxter 23,377,558 26,648 N.A. N.A. 2. Amendment to the Company's Amended and Restated Certificate of Incorporation 18,245,992 2,907,354 10,210 2,240,042 3. Amendment to 1997 Stock Incentive Plan 20,543,487 2,847,545 13,166 N.A. 4. Ratification of the Appointment of Auditors 23,349,330 49,910 4,958 N.A. </TABLE> -16-
PC CONNECTION, INC. AND SUBSIDIARIES Part II - Other Information - Cont'd. Item 5 - Other Information Not applicable. Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits -------- Exhibit Number Description ------- ----------- 10.46 Amendment, dated December 27, 2000 to the Amended and Restated Credit Agreement, dated February 25, 2000, between PC Connection, Inc., the Lender's Party hereto and Citizens Bank of Massachusetts. 10.47 Amendment, dated May 4, 2001 to the Amended and Restated Credit Agreement, dated December 27, 2000, between PC Connection, Inc., the Lender's Party hereto and Citizens Bank of Massachusetts. 10.48 Amendments, dated June 19, 2001 to the Assignment of Lease Agreements dated as of December 13, 1999, between Micro Warehouse Inc. (assignor) and the Registrant (assignee). 15 Letter on unaudited interim financial information. (b) Reports on Form 8-K ------------------- (i) The Company filed a current report on Form 8-K on June 5, 2001 for the Merger Agreement by and between PC Connection, Inc. and Cyberian Outpost, dated as of May 29, 2001. -17-
PC CONNECTION, INC. AND SUBSIDIARIES June 30, 2001 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. AND SUBSIDIARIES August 14, 2001 By: /s/ Wayne L. Wilson --------------------------------------------- Wayne L. Wilson President and Chief Operating Officer August 14, 2001 By: /s/ Mark A. Gavin --------------------------------------------- Mark A. Gavin Senior Vice President of Finance and Chief Financial Officer -18-