UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2011

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from             to            

 

Commission File Number: 0-25790

 

PC MALL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4518700

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

2555 West 190th Street, Suite 201

Torrance, CA 90504

(Address of principal executive offices)

 

(310) 354-5600

(Registrant’s telephone number, including area code)

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

As of August 10, 2011, the registrant had 12,410,903 shares of common stock outstanding.

 

 

 



 

PC MALL, INC.

 

TABLE OF CONTENTS

 

 

 

Page

PART I - FINANCIAL INFORMATION (unaudited)

 

 

 

 

 

Item 1. Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

 

2

 

 

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and June 30, 2010

 

3

 

 

 

Consolidated Statement of Stockholders’ Equity for the Six Months Ended June 30, 2011

 

4

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and June 30, 2010

 

5

 

 

 

Notes to the Consolidated Financial Statements

 

6

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

11

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

26

 

 

 

Item 4. Controls and Procedures

 

26

 

 

 

PART II - OTHER INFORMATION (unaudited)

 

 

 

 

 

Item 1. Legal Proceedings

 

27

 

 

 

Item 1A. Risk Factors

 

27

 

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

43

 

 

 

Item 6. Exhibits

 

43

 

 

 

Signature

 

44

 



 

PC MALL, INC.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except per share amounts and share data)

 

 

 

June 30,

 

December 31

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,017

 

$

10,711

 

Accounts receivable, net of allowances of $1,827 and $1,802

 

179,027

 

183,944

 

Inventories, net

 

59,240

 

63,583

 

Prepaid expenses and other current assets

 

12,284

 

10,022

 

Deferred income taxes

 

3,879

 

3,798

 

Total current assets

 

260,447

 

272,058

 

Property and equipment, net

 

35,409

 

21,851

 

Deferred income taxes

 

597

 

604

 

Goodwill

 

25,510

 

25,510

 

Intangible assets, net

 

11,749

 

11,749

 

Other assets

 

2,710

 

2,319

 

Total assets

 

$

336,422

 

$

334,091

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

103,101

 

$

124,851

 

Accrued expenses and other current liabilities

 

30,581

 

31,279

 

Deferred revenue

 

18,807

 

12,206

 

Line of credit

 

56,416

 

50,301

 

Notes payable — current

 

999

 

783

 

Total current liabilities

 

209,904

 

219,420

 

Notes payable and other long-term liabilities

 

12,170

 

4,607

 

Deferred income taxes

 

3,315

 

2,771

 

Total liabilities

 

225,389

 

226,798

 

Commitments and contingencies (Note 10)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; none issued and outstanding

 

 

 

Common stock, $0.001 par value; 30,000,000 shares authorized; 14,345,745 and 14,089,672 shares issued; and 12,404,573 and 12,148,500 shares outstanding, respectively

 

14

 

14

 

Additional paid-in capital

 

106,623

 

104,894

 

Treasury stock, at cost: 1,941,172 shares

 

(7,176

)

(7,176

)

Accumulated other comprehensive income

 

2,713

 

2,465

 

Retained earnings

 

8,859

 

7,096

 

Total stockholders’ equity

 

111,033

 

107,293

 

Total liabilities and stockholders’ equity

 

$

336,422

 

$

334,091

 

 

See Notes to the Consolidated Financial Statements.

 

2



 

PC MALL, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net sales

 

$

361,910

 

$

316,983

 

$

697,848

 

$

606,837

 

Cost of goods sold

 

315,524

 

276,428

 

607,993

 

528,253

 

Gross profit

 

46,386

 

40,555

 

89,855

 

78,584

 

Selling, general and administrative expenses

 

43,805

 

37,708

 

85,359

 

74,961

 

Operating profit

 

2,581

 

2,847

 

4,496

 

3,623

 

Interest expense, net

 

835

 

507

 

1,558

 

989

 

Income before income taxes

 

1,746

 

2,340

 

2,938

 

2,634

 

Income tax expense

 

710

 

977

 

1,175

 

1,098

 

Net income

 

$

1,036

 

$

1,363

 

$

1,763

 

$

1,536

 

Basic and Diluted Earnings Per Common Share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.08

 

$

0.11

 

$

0.14

 

$

0.13

 

Diluted

 

0.08

 

0.11

 

0.14

 

0.12

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

12,405

 

12,270

 

12,318

 

12,280

 

Diluted

 

12,750

 

12,565

 

12,679

 

12,596

 

 

See Notes to the Consolidated Financial Statements.

 

3



 

PC MALL, INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(unaudited, in thousands)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

 

 

Common Stock

 

Paid-in-

 

Treasury

 

Comprehensive

 

Retained

 

 

 

 

 

Outstanding

 

Amount

 

Capital

 

Stock

 

Income

 

Earnings

 

Total

 

Balance at December 31, 2010

 

12,149

 

$

14

 

$

104,894

 

$

(7,176

)

$

2,465

 

$

7,096

 

$

107,293

 

Stock option exercises, including related income tax benefit

 

256

 

 

667

 

 

 

 

 

667

 

Stock-based compensation expense

 

 

 

1,062

 

 

 

 

1,062

 

Subtotal

 

 

 

 

 

 

 

109,022

 

Net income

 

 

 

 

 

 

1,763

 

1,763

 

Translation adjustments

 

 

 

 

 

248

 

 

248

 

Comprehensive income

 

 

 

 

 

 

 

2,011

 

Balance at June 30, 2011

 

12,405

 

$

14

 

$

106,623

 

$

(7,176

)

$

2,713

 

$

8,859

 

$

111,033

 

 

See Notes to the Consolidated Financial Statements.

 

4



 

PC MALL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

Cash Flows From Operating Activities

 

 

 

 

 

Net income

 

$

1,763

 

$

1,536

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

4,619

 

3,731

 

Provision for deferred income taxes

 

620

 

421

 

Net tax benefit related to stock option exercises

 

2

 

43

 

Excess tax benefit related to stock option exercises

 

(660

)

(16

)

Non-cash stock-based compensation

 

1,062

 

1,167

 

Decrease in earnout liability

 

(800

)

 

Gain on sale of fixed assets

 

(15

)

(11

)

Change in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

4,917

 

(7,579

)

Inventories

 

5,327

 

15,677

 

Prepaid expenses and other current assets

 

(1,956

)

(3,833

)

Other assets

 

(100

)

115

 

Accounts payable

 

(29,497

)

(3,221

)

Accrued expenses and other current liabilities

 

(532

)

(2,997

)

Deferred revenue

 

6,601

 

4,130

 

Total adjustments

 

(10,412

)

7,627

 

Net cash (used in) provided by operating activities

 

(8,649

)

9,163

 

Cash Flows From Investing Activities

 

 

 

 

 

Purchase of El Segundo building

 

(9,565

)

 

Purchases of property and equipment

 

(5,194

)

(4,425

)

Acquisition of NSPI

 

 

(8,788

)

Acquisition of eCost

 

(2,284

)

 

Proceeds from sale of fixed assets

 

23

 

 

Net cash used in investing activities

 

(17,020

)

(13,213

)

Cash Flows From Financing Activities

 

 

 

 

 

Borrowing under note payable

 

7,198

 

 

Payments under notes payable

 

(368

)

(550

)

Net borrowings under line of credit

 

5,769

 

11,715

 

Change in book overdraft

 

7,660

 

(2,446

)

Payments of obligations under capital lease

 

(526

)

(313

)

Proceeds from stock issued under stock option plans

 

665

 

58

 

Payment for deferred financing costs

 

(25

)

 

Excess tax benefit related to stock option exercises

 

660

 

16

 

Common shares repurchased and held in treasury

 

 

(554

)

Net cash provided by financing activities

 

21,033

 

7,926

 

Effect of foreign currency on cash flow

 

(58

)

(103

)

Net change in cash and cash equivalents

 

(4,694

)

3,773

 

Cash and cash equivalents at beginning of the period

 

10,711

 

9,215

 

Cash and cash equivalents at end of the period

 

$

6,017

 

$

12,988

 

Supplemental Cash Flow Information

 

 

 

 

 

Interest paid

 

$

1,346

 

$

908

 

Income taxes paid

 

2,648

 

386

 

Supplemental Non-Cash Investing and Financing Activities

 

 

 

 

 

Purchase of infrastructure system

 

$

2,070

 

$

 

Deferred financing costs

 

49

 

 

NSPI acquisition related:

 

 

 

 

 

Fair value of assets, net of cash, acquired

 

$

 

$

13,472

 

Net cash paid

 

 

(8,788

)

Liabilities assumed

 

$

 

$

4,684

 

 

See Notes to the Consolidated Financial Statements.

 

5



 

PC MALL, INC.

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Basis of Presentation and Description of Company

 

PC Mall, Inc., founded in 1987, together with its wholly-owned subsidiaries (collectively referred to as “PC Mall,” “we” or “us”), is a value added direct marketer of technology products, services and solutions to businesses, government and educational institutions and individual consumers. We offer our products, services and solutions through dedicated account executives, field service teams, various direct marketing techniques and a limited number of retail stores. We also utilize distinctive full-color catalogs under the PC Mall, MacMall, PC Mall Gov, HealthDynamix and SARCOM brands and our websites pcmall.com, macmall.com, sarcom.com, pcmallgov.com, abreon.com, nspi.com, onsale.com, ecost.com, healthdynamix.com, pcmallsbn.com and other promotional materials.

 

PC Mall plays a valuable role in the IT supply chain. While we provide comprehensive solutions for our customers’ technology needs, our business model also provides significant leverage to technology manufacturers and service providers. Through us, technology manufacturers and service providers are able to reach multiple customer segments including consumers, small and medium sized businesses, large enterprise businesses, as well as state, local and federal governments and educational institutions. Our model also facilitates an efficient supply chain and support mechanism for manufacturers by using a combination of direct marketing, centralized selling and support, and centralized product fulfillment. Additionally, while our experience and expertise in marketing and eCommerce allows us to efficiently reach and capture customers across these segments, our scale and centralized model allow us to efficiently deploy a one-to-many selling and delivery model.

 

Beginning in the first quarter of 2011, in response to what we believe to be a rapidly changing way in which consumers shop and go to market, we expanded our business to enter the market for local daily deals through social commerce.  In connection with this expansion, in February 2011, we acquired certain assets eCost.com, a subsidiary of PFSweb, Inc., for $2.3 million. During the second quarter of 2011, we also expanded our existing OnSale.com website, in beta, to include the offering of deals in three local markets, Los Angeles, Chicago and Seattle. In conjunction with these changes, beginning with the first quarter of 2011, our management changed the way we internally look at our business and realigned our reportable operating segments from four segments (previously SMB, MME, Public Sector and MacMall) to five segments that we now refer to as SMB, MME, Public Sector, MacMall and OnSale. As such, existing sales under the OnSale brand will no longer be reported under the MacMall segment, but rather they will be reported, together with sales under the eCost brand, as part of the OnSale segment. We expect that our MacMall segment will remain primarily focused on targeting small businesses, creative professionals and high-end consumers, predominantly in the Apple and related products market. We will continue to include corporate related expenses such as legal, accounting, information technology, product management, certain support services and other administrative costs that are not otherwise allocated to our reportable operating segments in Corporate and Other. All historical segment financial information provided herein has been revised to reflect these new reportable operating segments.

 

Our SMB segment consists of sales made primarily to small and medium sized businesses, utilizing an outbound phone based sales force and, where applicable, a field-based sales force. In addition, the SMB segment markets to small businesses through its Small Business Network utilizing its own social network site at www.pcmallsbn.com.

 

Our MME segment consists of sales made primarily to mid-market and enterprise-sized businesses under the SARCOM, NSPI and Abreon brands, utilizing a field relationship-based selling model, an outbound phone based sales force and a field service organization. The MME segment sells complex products, services and solutions, which we believe can be delivered best with a face-to-face selling model.

 

Our Public Sector segment consists of sales made primarily to federal, state, and local governments, as well as educational institutions, utilizing an outbound phone and field relationship-based selling model as well as contracts and bids business development teams.

 

Our MacMall segment includes sales made under our MacMall brand name via telephone and the Internet to consumers, businesses and creative professionals.

 

Our OnSale segment currently includes sales made under our OnSale and eCost brand names primarily to consumers and small businesses via the Internet. During the second quarter of 2011, OnSale launched its expanded platform in beta through its existing website at www.OnSale.com to include the marketing of daily deals in local markets through social commerce.

 

6



 

2. Property and Equipment

 

On March 11, 2011, we completed the purchase of real property comprising approximately 184,000 square feet of land, which includes 82,000 square feet of office space located at 1940 East Mariposa Avenue, El Segundo, California, which will be our new corporate headquarters. Our plan is to move into this building from our current headquarters located in Torrance, California in early fall of 2011 before the expiration of the Torrance lease. The total purchase price was $9.6 million. Based on the proportionate appraised values, we allocated $7.4 million of the purchase price to land and $2.2 million to building. We expect to make certain improvements on the property for an expected cost of up to $4.5 million. Depreciation on the building will begin when the improvements are completed and the building is placed into service, which is currently expected to be in the second half of 2011. In June 2011, we entered into a credit agreement to finance the purchase and improvement of this real property. The credit agreement provides a commitment for a loan up to $10.9 million of which there was $7.2 million outstanding at a June 30, 2011. See Note 5 below for more information.

 

3. Acquisition

 

NSPI

 

In June 2010, Sarcom, Inc, our wholly-owned subsidiary, completed the acquisition of substantially all of the assets of Network Services Plus, Inc. (“NSPI”). NSPI, primarily a provider of hosted data center and managed IT services in the southeastern United States, had approximately 73 employees as of the closing date, 53 of whom are billable IT resources. The terms of the transaction included an initial purchase price of $7.8 million, less a customary hold-back to settle possible indemnity claims. In addition, we extinguished substantially all of NSPI’s indebtedness that existed immediately prior to the closing date of our acquisition. We have recorded identifiable intangible assets of $2.6 million related to customer relationships, $0.5 million related to trademarks and $0.3 million related to a non-compete agreement, with estimated useful lives of 10, 10 and 4 years, respectively. In addition, pursuant to the terms of the asset purchase agreement, NSPI’s shareholders can earn additional consideration based on the performance of the NSPI business over the next two years, up to a total of approximately $5.2 million. In accordance with ASC 805, based on an initial valuation of the fair value of the contingent consideration, we recorded additional goodwill and a corresponding liability of $3.2 million for future earnout payments. Such valuation was based upon management’s initial forecasts of expected profitability of NSPI during the earnout period. As of June 30, 2011, management updated its forecasts of expected profitability of NSPI during the earnout period, and lowered the future earnout liability to $2.4 million, resulting in a $0.8 million reduction of general and administrative expenses in our consolidated statement of operations during the three months ended June 30, 2011. These forecasts will be updated, if necessary, in future periods with adjustments reflected in our consolidated statement of operations.

 

4. Goodwill and Intangible Assets

 

Goodwill

 

There was no change in goodwill during the six months ended June 30, 2011. Goodwill totaled $25.5 million as of June 30, 2011 and December 31, 2010, all of which related to our MME segment.

 

Intangible Assets

 

The following table sets forth the amounts recorded for intangible assets as of the periods presented (in thousands):

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated

 

At June 30, 2011

 

At December 31, 2010

 

 

 

Useful Lives

 

Gross

 

Accumulated

 

Net

 

Gross

 

Accumulated

 

Net

 

 

 

(years)

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Amount

 

Patent, trademarks & URLs

 

8

 

$

6,509

(1)

$

279

 

$

6,230

 

$

5,925

(1)

$

203

 

$

5,722

 

Customer relationships

 

6

 

10,600

 

5,544

 

5,056

 

10,100

 

4,672

 

5,428

 

Non-compete agreements

 

4

 

1,070

 

607

 

463

 

1,070

 

471

 

599

 

Total intangible assets

 

 

 

$

18,179

 

$

6,430

 

$

11,749

 

$

17,095

 

$

5,346

 

$

11,749

 

 


(1)  Included in the total amount for “Patent, trademarks, & URLs” at June 30, 2011 and December 31, 2010 are $5.2 million of trademarks with indefinite useful lives acquired in the SARCOM acquisition that are not amortized.

 

7



 

On February 18, 2011, we acquired certain intangible assets of eCost.com, a subsidiary of PFSweb, Inc., as well as approximately $1 million of inventory and $0.3 million of software, for $2.3 million. Based on a preliminary analysis of the purchase price, as of June 30, 2011, the intangible assets, which are included in the table above under “Patent, trademarks & URLs” and “Customer relationships” were valued at $1.0 million.

 

Amortization expense for intangible assets was approximately $0.6 million and $0.4 million for the three months ended June 30, 2011 and 2010, respectively and approximately $1.1 million and $0.8 million for the six months ended June 30, 2011 and 2010.

 

Estimated amortization expense for intangible assets in each of the next five years and thereafter is as follows: $1.1 million in the remainder of 2011; $2.0 million in 2012; $1.0 million in 2013; $0.6 million in 2014; $0.5 million in 2015; and $1.3 million thereafter.

 

5. Line of Credit and Notes Payable

 

We maintain an asset-based revolving credit facility, as amended from time to time and most recently amended as of December 14, 2010, of up to $160 million from a lending unit of a large commercial bank. The credit facility provides for, among other things, (i) a credit limit of $160 million, which may be increased in increments of $5 million up to a total credit limit of $180 million, provided that any increase of the total credit limit in excess of $160 million is subject to, among other things, an acceptance and commitment by the lenders to such excess amount and a line increase fee not to exceed 0.65% of the increased amount; (ii) LIBOR interest rate options that we can enter into with no limit on the maximum outstanding principal balance which may be subject to a LIBOR interest rate option; and (iii) a maturity date of March 31, 2015. The credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which the Maximum Credit, as defined in the agreement, then in effect, exceeds the average daily principal balance of the outstanding borrowings during the immediately preceding month. There can be no assurance that the lenders, if we elected to increase the credit limit, will commit to the remaining excess $20 million of credit beyond the $160 million in any future period. As a result, we may not be able to access the credit facility beyond its current limit of $160 million.

 

The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum fixed charge coverage ratio (FCCR) requirement in the event an FCCR triggering event has occurred. An FCCR triggering event is comprised of maintaining certain specified daily and average excess availability thresholds. In the event the FCCR covenant applies, the fixed charge coverage ratio is 0.75 to 1.0 for periods ending on or prior to September 30, 2011, increasing to 1.0 to 1.0 for twelve-month periods ending on or after December 31, 2011. At June 30, 2011, we were in compliance with the financial covenant.

 

Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and utilization of early-pay discounts. At June 30, 2011, we had $56.4 million of net working capital advances outstanding under the line of credit. At June 30, 2011, the maximum credit line was $160 million and we had $61.0 million available to borrow for working capital advances under the line of credit.

 

In connection with and as part of the amended credit facility, we entered into an amended term note on December 14, 2010 with a principal balance of $2.87 million, payable in equal monthly principal installments beginning on January 1, 2011, plus interest at the prime rate with a LIBOR option. The amended term note matures in December 2017 or in the event of a default, termination or non-renewal of our credit facility, is payable in its entirety upon demand by our lender. At June 30, 2011, we had $2.67 million outstanding under the amended term note. The remaining balance of our term note matures as follows: $205,000 in the remainder of 2011 and $410,000 annually in each of the years 2012 through 2017.

 

At June 30, 2011, our effective weighted average annual interest rate on outstanding amounts under the credit facility and term note was 2.44%.

 

At June 30, 2011, $0.3 million and $0.1 million relating to the financing of our purchase of Microsoft AX (Axapta), which is a part of our ERP upgrade, were included in our “Notes payable — current” and “Notes payable and other long-term liabilities,” respectively, on our Consolidated Balance Sheets.

 

In June 2011, we entered into a credit agreement to finance the acquisition and improvement of real property we purchased in March 2011 in El Segundo, California. The credit agreement provides for a lending commitment for a loan up to $10.9 million with a five year term and a 25 year straight-line principal repayment amortization period with a balloon payment at maturity. Interest is variable, indexed to Prime plus a spread of 0.375% or LIBOR plus a spread of 2.375% at our option. At June 30, 2011, we had $7.2 million outstanding under this credit agreement. The loan is secured by the real property, and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

8



 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

6. Income Taxes

 

Accounting for Uncertainty in Income Taxes

 

ASC 740 clarifies the accounting for uncertainty in tax positions by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We had no unrecognized tax benefits and no accrued interest or penalties recognized as of the date of our adoption of ASC 740. During the three months ended June 30, 2011, there were no changes in our unrecognized tax benefits, and we had no accrued interest or penalties as of June 30, 2011.

 

We are subject to U.S. and foreign income tax examinations for years subsequent to 2005, and state income tax examinations for years following 2004. In addition, certain federal and state net operating loss carryforwards generated after 1998 and 1996, respectively, and used in a subsequent year, may still be adjusted by a taxing authority upon examination.

 

7. Earnings Per Share

 

Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the reported periods. Diluted EPS reflects the potential dilution that could occur under the treasury stock method if stock options and other commitments to issue common stock were exercised, except in loss periods where the effect would be antidilutive. As such, potential common shares of approximately 521,000 and 1,027,000 for the three months ended June 30, 2011 and 2010, and approximately 521,000 and 1,031,000 for the six months ended June 30, 2011 and 2010 have been excluded from the calculation of diluted EPS because the effect of their inclusion would be antidilutive.

 

The reconciliation of the amounts used in the basic and diluted EPS computation was as follows (in thousands, except per share amounts):

 

 

 

Net
Income

 

Shares

 

Per Share
Amounts

 

Three Months Ended June 30, 2011:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,036

 

12,405

 

$

0.08

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

345

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,036

 

12,750

 

$

0.08

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2010:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,363

 

12,270

 

$

0.11

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

295

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,363

 

12,565

 

$

0.11

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2011:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,763

 

12,318

 

$

0.14

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

361

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,763

 

12,679

 

$

0.14

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2010:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income

 

$

1,536

 

12,280

 

$

0.13

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

316

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted net income

 

$

1,536

 

12,596

 

$

0.12

 

 

9



 

8. Comprehensive Income

 

Our total comprehensive income was as follows for the periods presented (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net income

 

$

1,036

 

$

1,363

 

$

1,763

 

$

1,536

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

56

 

(292

)

248

 

(103

)

Total comprehensive income

 

$

1,092

 

$

1,071

 

$

2,011

 

$

1,433

 

 

9. Segment Information

 

Summarized segment information for our continuing operations for the periods presented is as follows (in thousands):

 

 

 

SMB

 

MME

 

Public
Sector

 

MacMall

 

OnSale

 

Corporate &
Other

 

Consolidated

 

Three Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

131,270

 

$

128,624

 

$

41,404

 

$

50,829

 

$

10,242

 

$

(459

)

$

361,910

 

Gross profit

 

16,837

 

19,859

 

3,356

 

5,328

 

978

 

28

 

46,386

 

Depreciation and amortization expense(1)

 

1

 

888

 

44

 

120

 

111

 

1,290

 

2,454

 

Operating profit (loss)

 

9,005

 

7,697

 

(344

)

1,407

 

(1,640

)

(13,544

)

2,581

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

107,709

 

$

125,482

 

$

41,109

 

41,988

 

$

710

 

$

(15

)

$

316,983

 

Gross profit

 

14,678

 

18,639

 

2,586

 

4,681

 

39

 

(68

)

40,555

 

Depreciation and amortization expense(1)

 

4

 

679

 

55

 

109

 

 

1,055

 

1,902

 

Operating profit (loss)

 

7,648

 

6,015

 

(821

)

1,317

 

(43

)

(11,269

)

2,847

 

Six Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

270,008

 

$

239,133

 

$

73,081

 

$

97,459

 

$

18,887

 

$

(720

)

$

697,848

 

Gross profit

 

33,755

 

37,845

 

6,553

 

10,221

 

1,897

 

(416

)

89,855

 

Depreciation and amortization expense(1)

 

4

 

1,763

 

96

 

243

 

112

 

2,401

 

4,619

 

Operating profit (loss)

 

18,189

 

12,856

 

(303

)

2,697

 

(2,152

)

(26,791

)

4,496

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

215,703

 

$

221,973

 

$

85,124

 

81,560

 

$

2,472

 

$

5

 

$

606,837

 

Gross profit

 

28,075

 

35,120

 

6,215

 

9,044

 

137

 

(7

)

78,584

 

Depreciation and amortization expense(1)

 

8

 

1,332

 

107

 

197

 

 

2,087

 

3,731

 

Operating profit (loss)

 

14,032

 

10,629

 

(443

)

1,949

 

(121

)

(22,423

)

3,623

 

 


(1) Primary fixed assets relating to network and servers are managed by the Corporate headquarters. As such, depreciation expense relating to such assets is included as part of Corporate and Other.

 

As of June 30, 2011 and December 31, 2010, we had total consolidated assets of $336.4 million and $334.1 million. Our management does not have available to them and does not use total assets measured at the segment level in allocating resources. Therefore, such information relating to segment assets is not provided herein.

 

10. Commitments and Contingencies

 

Total rent expense under our operating leases, net of sublease income, was $1.6 million and $1.7 million in each of the three month periods ended June 30, 2011 and June 30, 2010 and  $3.3 million and $3.4 million for the six months ended June 30, 2011 and 2010. Some of our leases contain renewal options and escalation clauses, and require us to pay taxes, insurance and maintenance costs.

 

Legal Proceedings

 

We are not currently a party to any legal proceedings with loss contingencies, which are expected to be material. From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation could result in a material amount of legal or related expenses and be time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

 

* *

 

10



 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations together with the consolidated financial statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described under “Risk Factors” in Item 1A and elsewhere in this report.

 

BUSINESS OVERVIEW

 

PC Mall, Inc., founded in 1987, together with its wholly-owned subsidiaries (collectively referred to as “PC Mall,” “we” or “us”), is a value added direct marketer of technology products, services and solutions to businesses, government and educational institutions and individual consumers. We offer our products, services and solutions through dedicated account executives, field service teams, various direct marketing techniques and a limited number of retail stores. We also utilize distinctive full-color catalogs under the PC Mall, MacMall, PC Mall Gov, HealthDynamix and SARCOM brands and our websites pcmall.com, macmall.com, sarcom.com, pcmallgov.com, abreon.com, nspi.com, onsale.com, ecost.com, healthdynamix.com, pcmallsbn.com and other promotional materials.

 

PC Mall plays a valuable role in the IT supply chain. While we provide comprehensive solutions for our customers’ technology needs, our business model also provides significant leverage to technology manufacturers and service providers. Through us, technology manufacturers and service providers are able to reach multiple customer segments including consumers, small and medium sized businesses, large enterprise businesses, as well as state, local and federal governments and educational institutions. Our model also facilitates an efficient supply chain and support mechanism for manufacturers by using a combination of direct marketing, centralized selling and support, and centralized product fulfillment. Additionally, while our experience and expertise in marketing and eCommerce allows us to efficiently reach and capture customers across these segments, our scale and centralized model allow us to efficiently deploy a one-to-many selling and delivery model.

 

Beginning in the first quarter of 2011, in response to what we believe to be a rapidly changing way in which consumers shop and go to market, we expanded our business to enter the market for local daily deals through social commerce.  In connection with this expansion, in February 2011, we acquired certain assets eCost.com, a subsidiary of PFSweb, Inc., for $2.3 million. During the second quarter of 2011, we also expanded our existing OnSale.com website, in beta, to include the offering of deals in three local markets, Los Angeles, Chicago and Seattle. In conjunction with these changes, beginning with the first quarter of 2011, our management changed the way we internally look at our business and realigned our reportable operating segments from four segments (previously SMB, MME, Public Sector and MacMall) to five segments that we now refer to as SMB, MME, Public Sector, MacMall and OnSale. As such, existing sales under the OnSale brand will no longer be reported under the MacMall segment, but rather they will be reported, together with sales under the eCost brand, as part of the OnSale segment. We expect that our MacMall segment will remain primarily focused on targeting small businesses, creative professionals and high-end consumers, predominantly in the Apple and related products market. We will continue to include corporate related expenses such as legal, accounting, information technology, product management, certain support services and other administrative costs that are not otherwise allocated to our reportable operating segments in Corporate and Other. All historical segment financial information provided herein has been revised to reflect these new reportable operating segments. See below for more information on our acquisition of eCost.com under “Strategic Developments — eCost.com Acquisition.”

 

Our SMB segment consists of sales made primarily to small and medium sized businesses, utilizing an outbound phone based sales force and, where applicable, a field-based sales force. In addition, the SMB segment markets to small businesses through its Small Business Network utilizing its own social network site at www.pcmallsbn.com, which ended the second quarter at June 30, 2011 with over 61,000 active users, who are primarily small businesses and IT executives.

 

Our MME segment consists of sales made primarily to mid-market and enterprise-sized businesses under the SARCOM, NSPI and Abreon brands, utilizing a field relationship-based selling model, an outbound phone based sales force and a field service organization. The MME segment sells complex products, services and solutions, which we believe can be delivered best with a face-to-face selling model.

 

Our Public Sector segment consists of sales made primarily to federal, state, and local governments, as well as educational institutions, utilizing an outbound phone and field relationship-based selling model as well as contracts and bids business development teams.

 

Our MacMall segment includes sales made under our MacMall brand name via telephone and the Internet to consumers, businesses and creative professionals.

 

11



 

Our OnSale segment currently includes sales made under our OnSale and eCost brand names primarily to consumers and small businesses via the Internet. During the second quarter of 2011, OnSale launched its expanded platform in beta through its existing website at www.OnSale.com to include the marketing of daily deals in local markets through social commerce.

 

We experience variability in our net sales and operating results on a quarterly basis as a result of many factors. We experience some seasonal trends in our sales of technology products, services and solutions to businesses, government and educational institutions and individual customers. For example, the timing of capital budget authorizations for our customers in the small and medium sized business sector and the mid-market and enterprise sector can affect when these companies can procure IT products and services. The fiscal year-ends of Public Sector customers vary for those in the federal government space and those in the state and local government and educational institution (“SLED”) sector. We generally see an increase in our second quarter sales related to customers in the SLED sector and in our third quarter sales related to customers in the federal government space as these customers close out their budgets for their fiscal year. Also, consumer holiday spending contributes to variances in our quarterly results. As such, the results of interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year.

 

There has been substantial ongoing uncertainty in the global economic environment and recent disruptions in the capital and credit markets. General economic conditions have an effect on our business and results of operations across all of our segments. If economic growth in the U.S. and other countries’ economies slows or declines, government, consumer and business spending rates could be significantly reduced. These developments could also increase the risk of uncollectible accounts receivable from our customers. Continued and future changes and uncertainties in the economic climate in the U.S. and elsewhere could have a similar negative impact on the rate of information technology spending of our current and potential customers, which would likely have a negative impact on our business and results of operations, and could significantly hinder our growth. These factors could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition, which could materially and adversely affect our business, results of operations and financial condition. In response to these uncertainties, we have continued to focus our efforts on cost reduction initiatives, competitive pricing strategies and driving higher margin service and solution sales, while continuing to make selective investments in our sales force personnel, service and solutions capabilities and IT infrastructure and tools in an effort to position us for enhanced productivity and future growth.

 

Our planned operating expenditures each quarter are based in large part on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow gross margins may magnify the impact of these factors on our operating results. Management regularly reviews our operating performance using a variety of financial and non-financial metrics including sales, shipments, gross margin, vendor consideration, advertising expense, personnel costs, account executive productivity, accounts receivable aging, inventory turnover, liquidity and cash resources. Our management monitors the various metrics against goals and budgets, and makes necessary adjustments intended to enhance our performance.

 

A substantial portion of our business is dependent on sales of Apple, HP, and products purchased from other vendors including Adobe, Cisco, IBM, Ingram Micro, Lenovo, Microsoft, Sony, Sun Microsystems and Tech Data. Products manufactured by Apple represented approximately 21% and 16% of our net sales in the three months ended June 30, 2011 and 2010, and 22% and 16% of our net sales in the six months ended June 30, 2011 and 2010. Products manufactured by HP represented 22% and 25% of our net sales in the three months ended June 30, 2011 and 2010, and 21% and 22% of our net sales in the six months ended June 30, 2011 and 2010.

 

One element of our business strategy involves expansion through the acquisition of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, or add new business capabilities. While we believe that the fragmented nature of the technology reseller industry and industry consolidation trends may continue to present acquisition opportunities for us, these continued trends may make acquisitions more competitive.

 

We evaluate acquisition opportunities based on our assessment of several factors, including the perceived value of the opportunity, our available financing sources, and potential synergies of the acquisition target with our business. Our ability to complete acquisitions in the future will depend on our ability to fund such acquisitions with our internally available cash, cash generated from operations, amounts available under our existing credit facilities, additional borrowings or from the issuance of additional securities. As more fully discussed under “Liquidity and Capital Resources” below, certain trends in our operating results may impact our available cash resources and availability under our credit facilities, which in turn may impact our ability to pursue our acquisition strategy.

 

12



 

STRATEGIC DEVELOPMENTS

 

eCost Acquisition

 

On February 18, 2011, we acquired certain intangible assets of eCost.com, a subsidiary of PFSweb, Inc., as well as approximately $1 million of inventory, for $2.3 million. eCost.com is an online marketplace featuring an assortment of product categories, including but not limited to computers, networking, electronics and entertainment, TVs, monitors and projectors, cameras and camcorders, memory and storage, apparel, and sports and leisure items. The website also features a proprietary and patented shopping format, Bargain Countdown®, which amongst other features, offers limited time, limited quantity deals, and supports its premium online membership shopping club. eCost commenced business in 1999 as a subsidiary of PC Mall. In September 2004, eCost.com completed an initial public offering of approximately 19.8% of its outstanding common stock. In April 2005, we completed a spin-off of eCost by distributing all of our remaining ownership interest in eCost to our stockholders. In February 2006, eCost was acquired by PFSweb in a stock for stock merger.

 

OnSale

 

Beginning in the first quarter of 2011, we expanded our business into the rapidly expanding market for daily deals by local merchants in local markets, leveraging the principles of social commerce and what we believe are our unique competitive advantages in that marketplace. In connection with this expansion, in February 2011, we acquired certain assets eCost.com as indicated above. During the second quarter of 2011, OnSale also launched its expanded daily deal platform in beta through its existing website at www.OnSale.com.

 

New Corporate Headquarters

 

On March 11, 2011, we completed the purchase of real property comprising approximately 184,000 square feet of land, which includes 82,000 square feet of office space located at 1940 East Mariposa Avenue, El Segundo, California, which will be our new corporate headquarters. Our plan is to move into this building from our current headquarters located in Torrance, California in early fall of 2011 before the expiration of the Torrance lease. The total purchase price was $9.6 million. Based on the proportionate appraised values, we allocated $7.4 million of the purchase price to land and $2.2 million to building. We expect to make certain improvements on the property for an expected cost of up to $4.5 million. Depreciation on the building will begin when the improvements are completed and the building is placed into service, which is currently expected to be in the second half of 2011. In June 2011, we entered into a credit agreement to finance the purchase and improvement of this real property. This credit agreement provides for a lending commitment for a loan up to $10.9 million. For more information, see below under “Liquidity and Capital Resources—Line of Credit and Note Payable.”

 

ERP and Web Infrastructure Upgrades

 

We are currently upgrading many of our IT systems. We have purchased licenses for Microsoft Dynamics AX (Axapta) and other related tools, such as workflow software, web development tools and other related items, to upgrade our ERP and eCommerce systems. We initiated the implementation and upgrade of our eCommerce system in the second half of 2008 and have completed and launched a new generation of our public sites at macmall.com, onsale.com and pcmall.com. We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features, and we expect to be complete with all phases of the implementation of the ERP systems by 2013. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. Based on our estimates, which are subject to change, we currently expect to incur a total cost of up to $14 million for all these IT system upgrades. To date, we have incurred approximately $8.8 million of such costs. In addition to the above expenditures, we expect on an ongoing basis to make periodic upgrades to our IT systems.

 

In addition to the upgrades to our IT systems, in July 2008, we entered into an agreement with Cisco Systems for the purchase and implementation of various solutions to upgrade our current infrastructure for a total cost of approximately $4.6 million. The purchase is financed through a capital lease over a five year term. We believe these upgrades have provided us with a unified platform for our entire company and a robust and efficient contact center. We completed the implementation of the Cisco solution across all of our locations in the second quarter of 2011.

 

13



 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses, as well as the disclosure of contingent assets and liabilities. Management bases its estimates, judgments and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Due to the inherent uncertainty involved in making estimates, actual results reported for future periods may be affected by changes in those estimates, and revisions to estimates are included in our results for the period in which the actual amounts become known.

 

Management considers an accounting estimate to be critical if:

 

·             it requires assumptions to be made that were uncertain at the time the estimate was made; and

·             changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial position.

 

Management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our board of directors. We believe the critical accounting policies described below affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a summary of our significant accounting policies, including those discussed below, see Note 2 of the Notes to the Consolidated Financial Statements in Item 8, Part II, of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Revenue Recognition. We adhere to the revised guidelines and principles of sales recognition described in ASC 605 (formerly Staff Accounting Bulletin No. 104, “Revenue Recognition,” issued by the staff of the SEC as a revision to Staff Accounting Bulletin No. 101, “Revenue Recognition”). Under ASC 605, product sales are recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed and determinable and collectability is reasonably assured. Under these guidelines, the majority of our sales, including revenue from product sales and gross outbound shipping and handling charges, are recognized upon receipt of the product by the customer. In accordance with our revenue recognition policy, we perform an analysis to estimate the number of days products we have shipped are in transit to our customers using data from our third party carriers and other factors. We record an adjustment to reverse the impact of sale transactions based on the estimated value of products that have shipped, but have not yet been received by our customers, and we recognize such amounts in the subsequent period when delivery has occurred. Changes in delivery patterns or unforeseen shipping delays beyond our control could have a material impact on our revenue recognition for the current period.

 

For all product sales shipped directly from suppliers to customers, we take title to the products sold upon shipment, bear credit risk, and bear inventory risk for returned products that are not successfully returned to suppliers; therefore, these revenues are recognized at gross sales amounts.

 

Certain software assurance or subscription products and extended warranties that we sell (for which we are not the primary obligor) are recognized on a net basis in accordance with ASC 605-45 (formerly Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”). Accordingly, such revenues are recognized in net sales either at the time of sale or over the contract period, based on the nature of the contract, at the net amount retained by us, with no cost of goods sold.

 

When a customer order contains multiple items such as hardware, software and services which are delivered at varying times, we determine whether the delivered items can be considered separate units of accounting as prescribed under ASC 605-25, Revenue Recognition, Multiple-Element Arrangement. ASC 605-25 states that delivered items should be considered separate units of accounting if delivered items have value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of undelivered items, and if delivery of undelivered items is probable and substantially in our control. Generally, we are able to establish fair value for all elements of the arrangement and revenue is recognized on each element separately.

 

Sales are reported net of estimated returns and allowances, discounts, mail-in rebate redemptions and credit card chargebacks. If the actual sales returns, allowances, discounts, mail-in rebate redemptions or credit card chargebacks are greater than estimated by management, additional expense may be incurred.

 

Allowance for Doubtful Accounts Receivable. We maintain an allowance for doubtful accounts receivable based upon estimates of future collection. We extend credit to our customers based upon an evaluation of each customer’s financial condition and credit history, and generally do not require collateral. We regularly evaluate our customers’ financial condition and credit history in determining the adequacy of our allowance for doubtful accounts. We also maintain an allowance for uncollectible vendor receivables,

 

14



 

which arise from vendor rebate programs, price protections and other promotions. We determine the sufficiency of the vendor receivable allowance based upon various factors, including payment history. Amounts received from vendors may vary from amounts recorded because of potential non-compliance with certain elements of vendor programs. If the estimated allowance for uncollectible accounts or vendor receivables subsequently proves to be insufficient, additional allowance may be required.

 

Reserve for Inventory Obsolescence. We maintain an allowance for the valuation of our inventory by estimating obsolete or unmarketable inventory based on the difference between inventory cost and market value, which is determined by general market conditions, nature, age and type of each product and assumptions about future demand. We regularly evaluate the adequacy of our inventory reserve. If our inventory reserve subsequently proves to be insufficient, additional allowance may be required.

 

Mail-In Rebate Redemption Rate Estimates. We accrue monthly expense related to promotional mail-in rebates based upon the quantity of eligible orders transacted during the period and the estimated redemption rate. The estimated expense is accrued and presented as a reduction of net sales. The estimated redemption rates used to calculate the accrued mail-in rebate expense and related mail-in rebate liability are based upon historical redemption experience rates for similar products or mail-in rebate amounts. Estimated redemption rates and the related mail-in rebate expense and liability are regularly adjusted as actual mail-in rebate redemptions for the program are processed. If actual redemption rates are greater than anticipated, additional expense may be incurred.

 

Vendor Consideration. We receive vendor consideration from our vendors in the form of cooperative marketing allowances, volume incentive rebates and other programs to support our marketing of their products. Most of our vendor consideration is accrued, when performance required for recognition is completed, as an offset to cost of sales in accordance with ASC 605-50 (formerly EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor”) since such funds are not a reimbursement of specific, incremental, identifiable costs incurred by us in selling the vendors’ products. As we circulate catalogs throughout the year, we also receive market development funds and other vendor consideration from vendors included in each catalog. These funds may be deferred, when warranted, and recognized based on sales generated over the life of the catalog. Deferred vendor consideration is included in “Accrued expenses and other current liabilities” in our Consolidated Balance Sheets. At the end of any given period, unbilled receivables related to our vendor consideration are included in our “Accounts receivable, net of allowances.”

 

Stock-Based Compensation. We account for stock-based compensation in accordance with ASC 718 (formerly financial Accounting Standards Board Statement No. 123 (revised 2004), “Share-Based Payment”), using the modified prospective application transition method. ASC 718 addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. ASC 718 generally requires that such transactions be accounted for using a fair value based method and recognized as expenses in our Consolidated Statements of Operations.

 

Pursuant to ASC 718, we estimate the grant date fair value of each stock option grant awarded pursuant to ASC 718 using the Black-Scholes option pricing model and management assumptions made regarding various factors, including expected volatility of our common stock, expected life of options granted and estimated forfeiture rates, which require extensive use of accounting judgment and financial estimates. In estimating our assumption regarding expected term for options we grant, we compute the expected term based upon an analysis of historical exercises of stock options by our employees. We compute our expected volatility using historical prices of our common stock for a period equal to the expected term of the options. The risk free interest rate is determined using the implied yield on U.S. Treasury issues with a remaining term within the contractual life of the award. We estimate an annual forfeiture rate based on our historical forfeiture data, which rate will be revised, if necessary, in future periods if actual forfeitures differ from those estimates. Any material change in the estimates used in calculating the stock-based compensation expense could result in a material impact on our results of operations.

 

Goodwill and Intangible Assets. Goodwill and indefinite-lived intangible assets are carried at historical cost, subject to write-down, as needed, based upon an impairment analysis that we perform annually, or sooner if an event occurs or circumstances change that would more likely than not result in an impairment loss. We perform our annual impairment test for goodwill and indefinite-lived intangible assets as of December 31 of each year. Under accounting guidance, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. Events that may create an impairment review include, but are not limited to, significant and sustained decline in our stock price or market capitalization, significant underperformance of operating units and significant changes in market conditions. Changes in estimates of future cash flows or changes in market values could result in a write-down of our goodwill in a future period. If an impairment loss results from any impairment analysis as described above, such loss will be recorded as a pre-tax charge to our operating income. Given continuing economic uncertainties and related risks to our business, there can be no assurance that our estimates and assumptions made for purposes of our goodwill and indefinite-lived intangible assets impairment testing as of December 31, 2010 will prove to be accurate predictions of the future. We may be required to record additional goodwill impairment charges in future periods, whether in connection with our next annual impairment testing as of December 31, 2011 or prior to that, if any change constitutes a triggering event outside of the quarter from when the annual goodwill and indefinite-lived intangible assets impairment test is performed. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material.

 

We amortize other intangible assets with definite lives generally on a straight-line basis over their estimated useful lives.

 

15



 

RESULTS OF OPERATIONS

 

Consolidated Statements of Operations Data

 

The following table sets forth, for the periods indicated, our Consolidated Statements of Operations (in thousands, unaudited) and information derived from our Consolidated Statements of Operations expressed as a percentage of net sales. There can be no assurance that trends in our net sales, gross profit or operating results will continue in the future.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net sales

 

$

361,910

 

$

316,983

 

$

697,848

 

$

606,837

 

Cost of goods sold

 

315,524

 

276,428

 

607,993

 

528,253

 

Gross profit

 

46,386

 

40,555

 

89,855

 

78,584

 

Selling, general and administrative expenses

 

43,805

 

37,708

 

85,359

 

74,961

 

Operating profit

 

2,581

 

2,847

 

4,496

 

3,623

 

Interest expense, net

 

835

 

507

 

1,558

 

989

 

Income before income taxes

 

1,746

 

2,340

 

2,938

 

2,634

 

Income tax expense

 

710

 

977

 

1,175

 

1,098

 

Net income

 

$

1,036

 

$

1,363

 

$

1,763

 

$

1,536

 

Basic and Diluted Earnings Per Common Share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.08

 

$

0.11

 

$

0.14

 

$

0.13

 

Diluted

 

0.08

 

0.11

 

0.14

 

0.12

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

12,405

 

12,270

 

12,318

 

12,280

 

Diluted

 

12,750

 

12,565

 

12,679

 

12,596

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold

 

87.2

 

87.2

 

87.1

 

87.1

 

Gross profit

 

12.8

 

12.8

 

12.9

 

12.9

 

Selling, general and administrative expenses

 

12.1

 

11.9

 

12.2

 

12.3

 

Operating profit

 

0.7

 

0.9

 

0.7

 

0.6

 

Interest expense, net

 

0.2

 

0.2

 

0.2

 

0.2

 

Income before income taxes

 

0.5

 

0.7

 

0.5

 

0.4

 

Income tax expense

 

0.2

 

0.3

 

0.2

 

0.2

 

Net income

 

0.3

%

0.4

%

0.3

%

0.2

%

 

Three Months Ended June 30, 2011 Compared to the Three Months Ended June 30, 2010

 

Net Sales. The following table presents our net sales, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

Change

 

 

 

2011

 

2010

 

$

 

%

 

SMB

 

$

131,270

 

$

107,709

 

$

23,561

 

21.9

%

MME

 

128,624

 

125,482

 

3,142

 

2.5

 

Public Sector

 

41,404

 

41,109

 

295

 

0.7

 

MacMall

 

50,829

 

41,988

 

8,841

 

21.1

 

OnSale

 

10,242

 

710

 

9,532

 

NMF

(1)

Corporate and Other

 

(459

)

(15

)

(444

)

NMF

(1)

Consolidated net sales

 

$

361,910

 

$

316,983

 

$

44,927

 

14.2

%

 


(1)  Not meaningful.

 

16



 

Our consolidated net sales for the second quarter of 2011 were $361.9 million, a $44.9 million or 14% increase from consolidated net sales of $317.0 million in the second quarter of 2010.

 

Our SMB segment net sales increased by $23.6 million, or 22%, in the second quarter of 2011 to $131.3 million from $107.7 million in the second quarter of 2010. The increase in SMB segment net sales was primarily due to an increase in sales to promotional companies, increased productivity of our account executives and continuing growth in our new Chicago office.

 

Our MME segment net sales increased by $3.1 million, or 3%, in the second quarter of 2011 to $128.6 million from $125.5 million in the second quarter of 2010. This increase was primarily due to a 13% increase in services revenues in the second quarter of 2011 compared to the second quarter of 2010. Service revenues represented 18% of MME net sales in the second quarter of 2011 compared to 17% of sales in the second quarter of 2010. The service revenue increase was primarily due to the inclusion of service revenues of NSPI, which we acquired in June 2010, as well as a 7% increase in service sales performed under our Abreon brand, which is primarily focused on change management and eLearning consulting. These increases in service revenues were partially offset by a 1% decrease in MME’s Sarcom branded lifecycle services in the second quarter of 2011 compared to the second quarter of 2010.

 

Our Public Sector segment net sales increased by $0.3 million, or 1%, in the second quarter of 2011 to $41.4 million compared to $41.1 million in the second quarter of 2010. This increase in Public Sector net sales was due to a 28% increase in our state and local government and educational institution sales driven by stronger demand, partially offset by a 23% decrease in our federal government business resulting primarily from a weak demand environment in the federal government sector.

 

As indicated previously, our MacMall segment no longer includes the OnSale business, and all historical numbers have been adjusted accordingly. Our MacMall segment net sales increased by $8.8 million, or 21%, in the second quarter of 2011 to $50.8 million compared to $42.0 million in the second quarter of 2010. This increase was primarily due to significant sales of iPads during the second quarter of 2011, and also reflects our ongoing efforts to focus on higher profit customer segments such as small businesses, creative professionals and high-end consumers.

 

Our OnSale segment currently includes sales made under our OnSale and eCost brand names primarily to consumers and small businesses via the Internet. During the second quarter of 2011, as discussed above, OnSale launched its expanded platform in beta through its existing website at www.OnSale.com to include the marketing of daily deals in local markets through social commerce. Our OnSale segment net sales increased by $9.5 million in the second quarter of 2011 to $10.2 million compared to $0.7 million in the second quarter of 2010. This increase was primarily due to a $5.2 million increase in sales through our traditional OnSale business and $4.3 million of net sales resulting from our acquisition of eCost in February 2011.

 

Gross Profit and Gross Profit Margin. The following table presents our gross profit and gross profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

 

 

 

 

 

 

2011

 

2010

 

 

 

 

 

 

 

 

 

Gross Profit

 

 

 

Gross Profit

 

Change

 

 

 

Gross Profit

 

Margin

 

Gross Profit

 

Margin

 

$

 

Margin

 

SMB

 

$

16,837

 

12.8

%

$

14,678

 

13.6

%

$

2,159

 

(0.8

)%

MME

 

19,859

 

15.4

 

18,639

 

14.9

 

1,220

 

0.5

 

Public Sector

 

3,356

 

8.1

 

2,586

 

6.3

 

770

 

1.8

 

MacMall

 

5,328

 

10.5

 

4,681

 

11.1

 

647

 

(0.6

)

OnSale

 

978

 

9.5

 

39

 

5.5

 

939

 

4.0

 

Corporate and Other

 

28

 

NMF

(1)

(68

)

NMF

(1)

96

 

NMF

(1)

Consolidated gross profit and gross profit margin

 

$

46,386

 

12.8

%

$

40,555

 

12.8

%

$

5,831

 

0.0

%

 


(1) Not meaningful

 

Consolidated gross profit for the second quarter of 2011 was $46.4 million compared to $40.6 million in the second quarter of 2010, a $5.8 million or 14% increase. Consolidated gross profit margin remained at 12.8% in the second quarter of 2011 and in the second quarter of 2010.

 

Gross profit for our SMB segment increased by $2.1 million, or 15%, to $16.8 million in the second quarter of 2011 compared to $14.7 million in the second quarter of 2010 resulting primarily from the increased SMB net sales discussed above and a $0.7 million increase in vendor consideration. SMB gross profit margin decreased to 12.8% in the second quarter of 2011 compared to 13.6% in the second quarter of 2010 primarily due to an increase in lower margin premium business sales as a percentage of the overall mix.

 

17



 

Gross profit for our MME segment increased by $1.3 million, or 7%, to $19.9 million in the second quarter of 2011 compared to $18.6 million in the second quarter of 2010, and MME gross profit margin increased to 15.4% in the second quarter of 2011 compared to 14.9% in the second quarter of 2010. The increase in MME gross profit and gross profit margin was primarily due to the increased MME net sales discussed above, which include a higher mix of service sales, as well as a $0.3 million, or a 14 basis point, increase in vendor consideration.

 

Gross profit for our Public Sector segment increased by $0.8 million, or 30%, to $3.4 million in the second quarter of 2011 compared to $2.6 million in the second quarter of 2010  Public Sector gross profit margin increased to 8.1% in the second quarter of 2011 compared to 6.3% in the second quarter of 2010. The increase in Public Sector gross profit was due to the increased Public Sector net sales discussed above and a $0.3 million increase in vendor consideration. The increase in Public Sector gross profit margin was primarily due to an increase in solution sales, which are made at higher margins.

 

Gross profit for our MacMall segment increased by $0.6 million, or 14%, to $5.3 million in the second quarter of 2011 compared to $4.7 million in the second quarter of 2010. MacMall gross profit margin decreased to 10.5% in the second quarter of 2011 compared to 11.1% in the second quarter of 2010. The increase in MacMall gross profit was primarily due to the increased MacMall net sales discussed above and an increase in vendor consideration. The decrease in gross profit margin was primarily due to an increase in sales of iPads which is a lower margin product category and also contributed to a 14 basis point decrease in vendor consideration as a percentage of net sales.

 

Gross profit for our OnSale segment increased to $1.0 million in the second quarter of 2011 compared to $39,000 in the second quarter of 2010. OnSale gross profit margin increased to 9.5% in the second quarter of 2011 compared to 5.5% in the second quarter of 2010. The increase in OnSale gross profit and gross profit margin was primarily due to the increased OnSale net sales discussed above and an improved product mix.

 

Operating Profit and Operating Profit Margin. The following table presents our operating profit and operating profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Three Months Ended
June 30,

 

 

 

 

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Operating

 

Operating
Profit

 

Operating

 

Operating
Profit

 

Change

 

 

 

Profit

 

Margin(1)

 

Profit

 

Margin(1)

 

$

 

Margin

 

SMB

 

$

9,005

 

6.9

%

$

7,648

 

7.1

%

$

1,357

 

(0.2

)%

MME

 

7,697

 

6.0

 

6,015

 

4.8

 

1,682

 

1.2

 

Public Sector

 

(344

)

(0.8

)

(821

)

(2.0

)

477

 

1.2

 

MacMall

 

1,407

 

2.8

 

1,317

 

3.1

 

90

 

(0.3

)

OnSale

 

(1,640

)

(16.0

)

(43

)

(6.1

)

(1,597

)

(9.9

)

Corporate and Other

 

(13,544

)

(3.7

)(1)

(11,269

)

(3.6

)(1)

(2,275

)

(0.1

)(1)

Consolidated operating profit and operating profit margin

 

$

2,581

 

0.7

%

$

2,847

 

0. 9

%

$

(266

)

(0.2

)%

 


(1)        Operating profit margin for Corporate and Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit for the second quarter of 2011 was $2.6 million compared to $2.8 million in the second quarter of 2010, a $0.2 million, or 9%, decrease. Consolidated operating profit margin for the second quarter of 2011 was 0.7% compared to 0.9% in the second quarter of 2010.

 

Our SMB segment operating profit increased by $1.4 million, or 18%, to $9.0 million in the second quarter of 2011 compared to $7.6 million in the second quarter of 2010. The increase in SMB operating profit in the second quarter of 2011 was primarily due to the increase in SMB gross profit discussed above, partially offset by a $0.4 million increase in SMB personnel costs, which was primarily due to an increase in variable compensation expenses related to the increased SMB gross profit, and a $0.2 million increase in credit card processing costs.

 

Our MME segment operating profit increased by $1.7 million, or 28%, to $7.7 million in the second quarter of 2011 compared to $6.0 million in the second quarter of 2010. The increase was primarily due to the increase in MME gross profit discussed above and $0.8 million of other income relating to a decrease in the estimated fair value of the contingent consideration liability related to the NSPI acquisition, partially offset by a $0.3 million increase in MME general and administrative costs primarily relating to the acquisition of NSPI.

 

18



 

Our Public Sector segment operating loss decreased by $0.5 million, or 58%, to $0.3 million in second quarter of 2011 compared to a loss of $0.8 million in second quarter of 2010. The decrease in Public Sector operating loss was primarily due to the increase in Public Sector gross profit discussed above, partially offset by a $0.2 million increase in bad debt expense primarily related to an external fraudulent transaction.

 

Our MacMall segment operating profit increased by $0.1 million to $1.4 million in the second quarter of 2011 compared to $1.3 million in the second quarter of 2010. This increase in MacMall operating profit was primarily due to the increase in MacMall gross profit discussed above, partially offset by a $0.2 million increase in advertising expenditures and a $0.3 million increase in variable costs.

 

Our OnSale segment operating loss increased to $1.6 million in the second quarter of 2011 compared to $43,000 in the second quarter of 2010. This increase in OnSale operating loss was primarily due to significant investments related to the expansion of our OnSale business model discussed above. In addition, advertising expenditures supporting our traditional OnSale business increased by $0.5 million. Our OnSale results include those from both OnSale and eCost, the assets of which we acquired in February of 2011. In the second quarter of 2011, we paid $0.3 million to the seller of eCost’s assets pursuant to a transition services agreement. We migrated eCost.com to our own systems in the latter part of second quarter of 2011, and as a result we do not believe the majority of those costs will recur in the third quarter or beyond. Further, OnSale’s results include approximately $0.3 million of start-up legal fees associated with its expanded business model, much of which we do not expect to recur going forward. However, we expect to continue to have an elevated level of expenditures for the foreseeable future related to the investments in the expansion of our OnSale business, which may result in continued operating losses for this segment.

 

Corporate & Other operating expenses includes corporate related expenses such as legal, accounting, information technology, product management and certain pre-sales, value-added support services and other administrative costs that are not otherwise included in our reportable operating segments. The second quarter 2011 Corporate & Other operating expenses increased by $2.2 million, or 20%, to $13.5 million from $11.3 million in the second quarter of 2010. The increase in the second quarter of 2011 was primarily related to an increase in personnel costs of $2.0 million resulting primarily from additions of technical resources, as well as IT and distribution personnel, a $0.5 million increase in litigation costs defending what we believe is a meritless lawsuit, a $0.2 million increase in telecommunications costs and a $0.2 million increase in depreciation, partially offset by a $0.7 million decrease in variable fulfillment costs.

 

Net Interest Expense. Total net interest expense for the second quarter of 2011 increased to $0.8 million compared with $0.5 million in the second quarter of 2010. The increase in interest expense of $0.3 million resulted primarily from an increase in our average effective borrowing rate, an increase in our average total outstanding borrowings in second quarter of 2011 compared to the second quarter of 2010 and an increase in amortization expense related to deferred financing costs.

 

Income Tax Expense. We recorded an income tax expense of $0.7 million in the second quarter of 2011 compared to an income tax expense of $1.0 million in the second quarter of 2010. Our effective tax rates for the quarters ended June 30, 2011 and 2010 were approximately 41% and 42%.

 

Six Months Ended June 30, 2011 Compared to the Six Months Ended June 30, 2010

 

Net Sales. The following table presents our net sales, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

Change

 

 

 

2011

 

2010

 

$

 

%

 

SMB

 

$

270,008

 

$

215,703

 

$

54,305

 

25.2

%

MME

 

239,133

 

221,973

 

17,160

 

7.7

 

Public Sector

 

73,081

 

85,124

 

(12,043

)

(14.1

)

MacMall

 

97,459

 

81,560

 

15,899

 

19.5

 

OnSale

 

18,887

 

2,472

 

16,415

 

664.0

 

Corporate and Other

 

(720

)

5

 

(725

)

NMF

(1)

Consolidated net sales

 

$

697,848

 

$

606,837

 

$

91,011

 

15.0

%

 


(1)  Not meaningful.

 

Our consolidated net sales for the six months ended June 30, 2011 were $697.8 million, a $91.0 million, or 15%, increase from consolidated net sales of $606.8 million in the six months ended June 30, 2010.

 

Our SMB segment net sales increased by $54.3 million, or 25%, to $270.0 million in the six months ended June 30, 2011 from $215.7 million in the six months ended June 30, 2010. The increase in SMB segment net sales was primarily due to an increase in sales to promotional companies, increased productivity of our account executives, continuing growth in our new Chicago office and continuing economic recovery by small and medium sized businesses.

 

19



 

Our MME segment net sales increased by $17.2 million, or 8%, to $239.1 million in the six months ended June 30, 2011 from $222.0 million in the six months ended June 30, 2010. This increase was primarily due to increased account executive productivity and increased IT spending by customers in the mid-market and enterprise sector in the six months ended June 30, 2011. Service revenues increased by 15% in the six months ended June 30, 2011 compared to the same period in 2010 while product revenues increased by 6% in the six months ended June 30, 2011 compared to the same period in 2010. Service revenues represented 19% of MME net sales in the six months ended June 30, 2011 compared to 18% of net sales in the six months ended June 30, 2010. The service revenue increase was primarily due to the inclusion of service revenues of NSPI, which we acquired in June 2010, as well as an 11% increase in service sales performed under our Abreon brand, which is primarily focused on change management and eLearning consulting. These increases in service revenues were partially offset by a 4% decrease in MME’s Sarcom branded lifecycle services in the six months ended June 30, 2011 compared to the six months ended June 30, 2010.

 

Our Public Sector segment net sales decreased by $12.0 million, or 14%, to $73.1 million in the six months ended June 30, 2011 compared to $85.1 million in the six months ended June 30, 2010.  This increase in Public Sector net sales was due to a 19% increase in our state and local government and educational institution sales driven by stronger demand, partially offset by a 34% decrease in our federal government business resulting primarily from a weak demand environment in the federal government business.

 

Our MacMall segment net sales increased by $15.9 million, or 19%, to $97.5 million in the six months ended June 30, 2011 compared to $81.6 million in the six months ended June 30, 2010. This increase was primarily due to significant sales of iPads during the six months ended June 30, 2011, and also reflects our ongoing efforts to focus on higher profit customer segments such as small businesses, creative professionals and high-end consumers.

 

Our OnSale segment net sales increased by $16.4 million in the six months ended June 30, 2011 to $18.9 million compared to $2.5 million in the six months ended of June 30, 2010. This increase was primarily due to a $10.4 million increase in sales through our traditional OnSale business and $6.0 million of net sales resulting from our acquisition of eCost in February 2011.

 

Gross Profit and Gross Profit Margin. The following table presents our gross profit and gross profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

 

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Gross Profit

 

 

 

Gross Profit

 

Change

 

 

 

Gross Profit

 

Margin

 

Gross Profit

 

Margin

 

$

 

Margin

 

SMB

 

$

33,755

 

12.5

%

$

28,075

 

13.0

%

$

5,680

 

(0.5

)%

MME

 

37,845

 

15.8

 

35,120

 

15.8

 

2,725

 

0.0

 

Public Sector

 

6,553

 

9.0

 

6,215

 

7.3

 

338

 

1.7

 

MacMall

 

10,221

 

10.5

 

9,044

 

11.1

 

1,177

 

(0.6

)

OnSale

 

1,897

 

10.0

 

137

 

5.5

 

1,760

 

4.5

 

Corporate and Other

 

(416

)

NMF

(1)

(7

)

NMF

(1)

(409

)

NMF

(1)

Consolidated gross profit and gross profit margin

 

$

89,855

 

12.9

%

$

78,584

 

12.9

%

$

11,271

 

0.0

%

 


(1) Not meaningful

 

Consolidated gross profit for the six months ended June 30, 2011 was $89.9 million compared to $78.6 million in the six months ended June 30, 2010, an $11.3 million or 14% increase. Consolidated gross profit margin remained at 12.9% in the six months ended June 30, 2011 and in the six months ended June 30, 2010.

 

Gross profit for our SMB segment increased by $5.7 million, or 20%, to $33.8 million for the six months ended June 30, 2011 compared to $28.1 million in the six months ended June 30, 2010 resulting primarily from increased SMB net sales discussed above. SMB gross profit margin decreased by 50 basis points to 12.5% in the six months ended June 30, 2011 compared to 13.0% in the six months ended June 30, 2010 primarily due to a 27 basis point decrease in vendor consideration as a percentage of sales and growth in lower margin premium business as a percentage of total sales.

 

Gross profit for our MME segment increased by $2.7 million, or 8%, to $37.8 million in the six months ended June 30, 2011 compared to $35.1 million in the six months ended June 30, 2010, and gross profit margin remained flat at 15.8% in the six months ended June 30, 2011 and in the six months ended June 30, 2010. The increase in MME gross profit was primarily due to the increased MME net sales discussed above.

 

20



 

Gross profit for our Public Sector segment increased by $0.4 million, or 5%, to $6.6 million in the six months ended June 30, 2011 compared to $6.2 million in the six months ended June 30, 2010. Public Sector gross profit margin increased by 170 basis points to 9.0% in the six months ended June 30, 2011 compared to 7.3% in the six months ended June 30, 2010. The increase in our Public Sector gross profit was primarily due to a $0.6 million increase in vendor consideration, partially offset by the decrease in Public Sector net sales discussed above. The increase in Public Sector gross profit margin was primarily due to a 108 basis point increase in vendor consideration as a percentage of sales as well as an increase in solution sales, which are made at higher margins.

 

Gross profit for our MacMall segment increased by $1.2 million, or 13%, to $10.2 million in the six months ended June 30, 2011 compared to $9.0 million in the six months ended June 30, 2010. MacMall gross profit margin decreased by 60 basis points to 10.5% in the six months ended June 30, 2011 compared to 11.1% in the six months ended June 30, 2010. The increase in our MacMall gross profit was primarily due to the increase in MacMall net sales discussed above and a $0.6 million increase in vendor consideration. The decrease in our MacMall gross profit margin was primarily due to increased sales of iPads, which is a lower margin product category.

 

Gross profit for our OnSale segment increased by $1.8 million to $1.9 million in the six months ended June 30, 2011 compared to $0.1 million in the six months ended June 30, 2010. OnSale gross profit margin increased by 450 basis points to 10.0% in the six months ended June 30, 2011 compared to 5.5% in the six months ended June 30, 2010. The increase in OnSale gross profit and gross profit margin was primarily due to the increased OnSale net sales discussed above and an improved product mix.

 

Operating Profit and Operating Profit Margin. The following table presents our operating profit and operating profit margin, by segment, for the periods presented (dollars in thousands):

 

 

 

Six Months Ended
June 30,

 

 

 

 

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Operating

 

Operating
Profit

 

Operating

 

Operating
Profit

 

Change

 

 

 

Profit

 

Margin(1)

 

Profit

 

Margin(1)

 

$

 

Margin

 

SMB

 

$

18,189

 

6.7

%

$

14,032

 

6.5

%

$

4,157

 

0.2

%

MME

 

12,856

 

5.4

 

10,629

 

4.8

 

2,227

 

0.6

 

Public Sector

 

(303

)

(0.4

)

(443

)

(0.5

)

140

 

0.1

 

MacMall

 

2,697

 

2.8

 

1,949

 

2.4

 

748

 

0.4

 

OnSale

 

(2,152

)

(11.4

)

(121

)

(4.9

)

(2,031

)

(6.5

)

Corporate and Other

 

(26,791

)

(3.8

)(1)

(22,423

)

(3.7

)(1)

(4,368

)

(0.1

)(1)

Consolidated operating profit and operating profit margin

 

$

4,496

 

0.6

%

$

3,623

 

0.6

%

$

873

 

0.0

%

 


(1)        Operating profit margin for Corporate and Other is computed based on consolidated net sales. Operating profit margin for each of the other segments is computed based on the respective segment’s net sales.

 

Consolidated operating profit for the six months ended June 30, 2011 was $4.5 million compared to $3.6 million in the six months ended June 30, 2010, a $0.9 million, or 24%, increase. Consolidated operating profit margin for the six months ended June 30, 2011 and 2010 was 0.6%.

 

Our SMB segment operating profit increased by $4.2 million, or 30%, to $18.2 million in the six months ended June 30, 2011 compared to $14.0 million in the six months ended June 30, 2010. The increase was primarily due to the increase in SMB gross profit discussed above, partially offset by a $1.1 million increase in SMB personnel costs, a $0.2 million increase in credit card processing costs and a $0.2 million increase in bad debt expense. The increase in personnel costs in the six months ended June 30, 2011 was primarily due to an increase in variable commission and bonus expenses due to the increased SMB gross profit and continued investment in our Chicago office and our addition of account executives in that facility.

 

Our MME segment operating profit increased by $2.3 million, or 21%, to $12.9 million in the six months ended June 30, 2011 compared to $10.6 million in the six months ended June 30, 2010. The increase was primarily due to the increase in MME gross profit discussed above and $0.8 million of other income relating to a decrease in the estimated fair value of the contingent consideration liability related to the NSPI acquisition, partially offset by a $0.8 million increase in variable fulfillment costs and a $0.4 million increase in depreciation and amortization expenses primarily relating to the acquisition of NSPI.

 

Public Sector segment reported an operating loss of $0.3 million in the six months ended June 30, 2011 compared to an operating loss of $0.4 million in the six months ended June 30, 2010. The decrease in Public Sector operating loss was primarily due to the increase in Public Sector gross profit discussed above and a $0.2 million decrease in advertising expenditures, partially offset by a $0.2 million increase in bad debt expense primarily related to an external fraudulent transaction and a $0.1 million increase in variable fulfillment costs.

 

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MacMall segment operating profit increased by $0.8 million, or 38%, to $2.7 million in the six months ended June 30, 2011 compared to $1.9 million in the six months ended June 30, 2010. The increase in MacMall segment operating profit was primarily due to the increase in MacMall segment gross profit discussed above, partially offset by a $0.2 million increase in personnel costs and a $0.3 million increase in credit card related costs.

 

Our OnSale segment reported an operating loss of $2.2 million in the six months ended June 30, 2011 compared to an operating loss of $0.1 million in the six months ended June 30, 2010. This increase in OnSale operating loss was primarily due to significant start-up and advertising costs for the expansion of our OnSale business model discussed above.

 

Corporate and Other SG&A expenses increased by $4.4 million, or 19%, to $26.8 million in the six months ended June 30, 2011 from $22.4 million in the six months ended June 30, 2010. This increase was primarily due to a $3.4 million increase in personnel costs resulting primarily from additions of technical resources, as well as IT and distribution personnel, a $0.4 million increase in litigation costs primarily due to defending what we believe is a meritless lawsuit and a $0.3 million increase in depreciation expense primarily related to the completed portions of our ERP and infrastructure upgrades.

 

Net Interest Expense. Total net interest expense for the six months ended June 30, 2011 increased to $1.6 million compared with $1.0 million in the six months ended June 30, 2010. The increase in interest expense of $0.6 million resulted primarily from an increase in our average effective borrowing rate as well as an increase in amortization expense related to deferred financing costs.

 

Income Tax Expense. We recorded an income tax expense of $1.2 million in the six months ended June 30, 2011 compared to an income tax expense of $1.1 million in the six months ended June 30, 2010. Our effective tax rates for the six months ended June 30, 2011 and 2010 were approximately 40% and 42%.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Working Capital. Our primary capital need has historically been funding the working capital requirements created by our growth in sales and strategic acquisitions. We expect that our primary capital needs will continue to be the funding of our existing working capital requirements, capital expenditures for which we expect to include substantial investments in a new ERP system, eCommerce platform and an upgrade of our current IT infrastructure over the next several years, which are discussed below in “Other Planned Capital Projects,” possible sales growth, possible acquisitions and new business ventures, including the expansion of our OnSale business, and possible repurchases of our common stock under a discretionary repurchase program, which we previously announced. Our primary sources of financing have historically come from borrowings from financial institutions, public and private issuances of our common stock and cash flows from operations. Our efforts to focus on SMB, MME and Public Sector sales could result in an increase in our accounts receivable as these customers are generally provided longer payment terms than consumers. We also expect that we will incur elevated levels of cash expenditures as we continue to invest in the expansion of our OnSale business. We historically have increased our inventory levels from time to time to take advantage of strategic manufacturer promotions. We believe that our current working capital, including our existing cash balance, together with our expected future cash flows from operations and available borrowing capacity under our line of credit, will be adequate to support our current operating plans for at least the next 12 months. However, the current uncertainty in the macroeconomic environment may limit our cash resources that could otherwise be available to fund future strategic opportunities, capital investments or growth beyond our current operating plans.

 

There has been substantial ongoing weakness in the global economic environment, coupled with disruptions in the capital and credit markets. While we recently entered into an amendment to our revolving credit facility as discussed in more detail below, we believe continued problems in these areas could have a negative impact on our ability to obtain future financing if we need additional funds, such as for acquisitions or expansion, to fund a significant downturn in our sales or an increase in our operating expenses, or to take advantage of opportunities or favorable market conditions, in the future. We may seek additional financing from public or private debt or equity issuances; however, there can be no assurance that such financing will be available at acceptable terms, if at all. Also, there can be no assurance that the cost or availability of future borrowings, if any, under our credit facility or in the debt markets will not be impacted by disruptions in the capital and credit markets.

 

We had cash and cash equivalents of $6.0 million at June 30, 2011 and $10.7 million at December 31, 2010. Our working capital was $50.5 million as of June 30, 2011 and $52.6 million as of December 31, 2010.

 

We maintain a Canadian call center serving the U.S. market, which has historically received the benefit of labor credits under a Canadian government program. In 2007, we received an eligibility certificate to participate in the Investment Quebec Refundable Tax Credit for Major Employment Generating Projects (GPCE), replacing the prior government subsidy program which ended at the end of 2007. In addition to other eligibility requirements under the new program, we are required to maintain a minimum of 317 eligible employees employed by our subsidiary PC Mall Canada, Inc. in the province of Quebec at all times to remain eligible to apply

 

22



 

annually for these labor credits. As a result of this new certification, we are eligible to make annual labor credit claims for eligible employees equal to 25% of eligible salaries, but not to exceed $15,000 (Canadian) per eligible employee per year, beginning in fiscal year 2008 and continuing through fiscal year 2016. Under the prior program through the end of 2007, we claimed annual labor credits of up to 35% of eligible compensation paid to our qualifying employees. As of June 30, 2011, we had an accrued receivable of $8.9 million related to the 2009 and 2010 calendar years and the first half of 2011, and we expect to receive full payment under our labor credit claims.

 

Cash Flows from Operating Activities. Net cash used in operating activities was $8.6 million in the six months ended June 30, 2011 compared to net cash provided by operating activities of $9.2 million in the six months ended June 30, 2010. The $17.8 million increase in net cash used in operating activities in the six months ended June 30, 2011 compared to the six months ended June 30, 2010 was primarily due to an $17.5 million decrease in our working capital, which was primarily related to a $26.3 million increase in our accounts payable, a $10.4 million decrease in inventory, partially offset by a $12.5 million increase in accounts receivable. This $26.3 million increase in accounts payable is primarily due to the mix and timing of trade payables, including our utilization of early pay discounts. The $10.4 million decrease in inventory was primarily related to a sell through in the six months ended June 30, 2010 of a large amount of seasonal inventory purchased in late 2009 as well as sell through of our Public Sector segment backlog in the six months ended June 30, 2010 partially offset by an increase in tablet inventory in the first half of 2011. The $12.5 million increase in accounts receivable was primarily related to an improvement in DSO in 2011 compared to 2010, partially due to the slowdown in Federal government spending.

 

Cash Flows from Investing Activities. Net cash used in investing activities was $17.0 million in the six months ended June 30, 2011 compared to $13.2 million in the six months ended June 30, 2010, related to capital expenditures in each period. Capital expenditures of $17.0 million in the six months ended June 30, 2011 were primarily related to investments in our IT infrastructure and the creation of enhanced electronic tools for our account executives and sales support staff, the $9.6 million purchase of a new headquarters office building in El Segundo, California, as discussed above, and the $2.3 million acquisition of certain assets of eCost. Capital expenditures in the six months ended June 30, 2010 were primarily related to the $8.8 million, net of cash acquired, used for the acquisition of certain assets of NSPI in June 2010 and $4.4 million of capital expenditures, which were primarily related to investments in our IT infrastructure, leasehold improvements relating to our relocated retail store in Torrance, California and the creation of enhanced electronic tools for our account executives and sales support staff.

 

Cash Flows from Financing Activities. Net cash provided by financing activities for the six months ended June 30, 2011 was $21.0 million compared to $7.9 million in the six months ended June 30, 2010. The $21.0 million of net cash provided by financing activities in the six months ended June 30, 2011 was primarily related to $7.2 million of borrowings under a new note payable to finance a part of the purchase price of the building in El Segundo, a $7.7 million change in book overdraft and a $5.8 million of net borrowings on our line of credit. The $7.9 million of net cash provided by financing activities in the six months ended June 30, 2010 was primarily due to the $11.7 million of net borrowings on our line of credit, of which $9.8 million was related to our acquisition of certain assets of NSPI, partially offset by a $2.4 million change in book overdraft.

 

Line of Credit and Note Payable. We maintain an asset-based revolving credit facility, as amended from time to time and most recently amended as of December 14, 2010, of up to $160 million from a lending unit of a large commercial bank. The credit facility provides for, among other things, (i) a credit limit of $160 million, which may be increased in increments of $5 million up to a total credit limit of $180 million, provided that any increase of the total credit limit in excess of $160 million is subject to, among other things, an acceptance and commitment by the lenders to such excess amount and a line increase fee not to exceed 0.65% of the increased amount; (ii) LIBOR interest rate options that we can enter into with no limit on the maximum outstanding principal balance which may be subject to a LIBOR interest rate option; and (iii) a maturity date of March 31, 2015. The credit facility, which functions as a working capital line of credit with a borrowing base of inventory and accounts receivable, including certain credit card receivables, also includes a monthly unused line fee of 0.25% per year on the amount, if any, by which the Maximum Credit, as defined in the agreement, then in effect, exceeds the average daily principal balance of the outstanding borrowings during the immediately preceding month. There can be no assurance that the lenders, if we elected to increase the credit limit, will commit to the remaining excess $20 million of credit beyond the $160 million in any future period. As a result, we may not be able to access the credit facility beyond its current limit of $160 million.

 

The credit facility is collateralized by substantially all of our assets. In addition to the security interest required by the credit facility, certain of our vendors have security interests in some of our assets related to their products. The credit facility has as its single financial covenant a minimum fixed charge coverage ratio (FCCR) requirement in the event an FCCR triggering event has occurred. An FCCR triggering event is comprised of maintaining certain specified daily and average excess availability thresholds. In the event the FCCR covenant applies, the fixed charge coverage ratio is 0.75 to 1.0 for periods ending on or prior to September 30, 2011, increasing to 1.0 to 1.0 for twelve-month periods ending on or after December 31, 2011. At June 30, 2011, we were in compliance with the financial covenant.

 

23



 

Loan availability under the line of credit fluctuates daily and is affected by many factors, including eligible assets on-hand, opportunistic purchases of inventory and availability and utilization of early-pay discounts. At June 30, 2011, we had $56.4 million of net working capital advances outstanding under the line of credit. At June 30, 2011, the maximum credit line was $160 million and we had $61.0 million available to borrow for working capital advances under the line of credit.

 

In connection with and as part of the amended credit facility, we entered into an amended term note on December 14, 2010 with a principal balance of $2.87 million, payable in equal monthly principal installments beginning on January 1, 2011, plus interest at the prime rate with a LIBOR option. The amended term note matures in December 2017 or in the event of a default, termination or non-renewal of our credit facility, is payable in its entirety upon demand by our lender. At June 30, 2011, we had $2.67 million outstanding under the amended term note. The remaining balance of our term note matures as follows: $205,000 in the remainder of 2011 and $410,000 annually in each of the years 2012 through 2017.

 

At June 30, 2011, our effective weighted average annual interest rate on outstanding amounts under the credit facility and term note was 2.44%.

 

At June 30, 2011, $0.3 million and $0.1 million relating to the financing of our purchase of Microsoft AX (Axapta), which is a part of our ERP upgrade, were included in our “Notes payable — current” and “Notes payable and other long-term liabilities,” respectively, on our Consolidated Balance Sheets.

 

In June 2011, we entered into a credit agreement to finance the acquisition and improvement of real property we purchased in March 2011 in El Segundo, California. The credit agreement provides a lending commitment for a loan up to $10.9 million with a five year term and a 25 year straight-line principal repayment amortization period with a balloon payment at maturity. Interest is variable, indexed to Prime plus a spread of 0.375% or LIBOR plus a spread of 2.375% at our option. At June 30, 2011, we had $7.2 million outstanding under this credit agreement. The loan is secured by the real property, and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

The carrying amounts of our line of credit borrowings and notes payable approximate their fair value based upon the current rates offered to us for obligations of similar terms and remaining maturities.

 

As part of our growth strategy, we may, in the future, make acquisitions in the same or complementary lines of business, and pursue other business ventures. Any launch of a new business venture or any acquisition and the ensuing integration of the acquired operations would place additional demands on our management, and our operating and financial resources.

 

Other Planned Capital Projects

 

We are currently upgrading many of our IT systems. We have purchased licenses for Microsoft Dynamics AX (Axapta) and other related tools, such as workflow software, web development tools and other related items, to upgrade our ERP and eCommerce systems. We initiated the implementation and upgrade of our eCommerce system in the second half of 2008 and have completed and launched a new generation of our public sites at macmall.com, onsale.com and pcmall.com. We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features, and we expect to be complete with all phases of the implementation of the ERP systems by 2013. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. Based on our estimates, which are subject to change, we currently expect to incur a total cost of up to $14 million for all these IT system upgrades. To date, we have incurred approximately $8.8 million of such costs. In addition to the above expenditures, we expect on an ongoing basis to make periodic upgrades to our IT systems.

 

In addition to the upgrades to our IT systems, in July 2008, we entered into an agreement with Cisco Systems for the purchase and implementation of various solutions to upgrade our current infrastructure for a total cost of approximately $4.6 million. The purchase is financed through a capital lease over a five year term. We believe these upgrades have provided us with a unified platform for our entire company and a robust and efficient contact center. We completed the implementation of the Cisco solution across all of our locations in the second quarter of 2011.

 

Inflation

 

Inflation has not had a material impact on our operating results; however, there can be no assurance that inflation will not have a material impact on our business in the future.

 

24



 

Dividend Policy

 

We have never paid cash dividends on our capital stock and our credit facility prohibits us from paying any cash dividends on our capital stock. Therefore, we do not currently anticipate paying dividends; we intend to retain any earnings to finance the growth and development of our business.

 

Off-Balance Sheet Arrangements

 

As of June 30, 2011, we did not have any off-balance sheet arrangements.

 

Contingencies

 

For a discussion of contingencies, see Part I, Item 1, Note 10 of the Notes to the Consolidated Financial Statements of this report, which is incorporated herein by reference.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such statements include statements regarding our expectations, hopes or intentions regarding the future, including but not limited to, statements regarding our strategies, competition, markets, vendors, expenses, new services and technologies, growth prospects, financing, revenue, margins, operations, litigation and compliance with applicable laws. In particular, the following types of statements are forward-looking:

 

·              our use of management information systems and their need for future support or upgrade;

·              our expectations regarding the timing and costs of our ongoing or planned IT upgrades;

·              our ability to execute and benefit from our business strategies; including but not limited to, business strategies related to and strategic investments in our IT systems, our Chicago office, HealthDynamix, our Small Business Network and our acquisition of assets of eCost.com and related strategies for our expected future OnSale segment;

·             our competitive advantages and growth opportunities;

·             our ability to increase profitability and revenues;

·             our expectations to continue our efforts to increase the productivity of our sales force and reduce costs;

·             our ability to generate vendor supported marketing;

·             our acquisition strategy and the impact of any past or future acquisitions;

·             the impact of acquisitions on our financial condition, liquidity and our future cash flows and earnings;

·             our expectations regarding the expansion of our OnSale business into the market for daily deals;

·             our expectation regarding general economic uncertainties and the related potential negative impact on our profit and profit margins, as well as our financial condition, liquidity and future cash flows;

·             our expectations regarding our future capital needs and the availability of working capital, liquidity, cash flows from operations and borrowings under our credit facility;

·             the impact on accounts receivable from our efforts to focus on sales in our MME, SMB, and Public Sector segments;

·             our ability to penetrate the public sector market and the impact of changes to our public sector business related to key changes to a primary vendor’s programs;

·             our beliefs relating to the benefits to be received from our Philippines office and Canadian call center, including tax credits and reduction in labor costs over time;

·             our belief regarding our exposure to currency exchange and interest rate risks;

·             our ability to attract new customers and stimulate additional purchases from existing customers, including our expectations regarding future advertising levels and the effect on consumer sales;

·             our ability to leverage our market position and purchasing power and offer a wide selection of products at competitive prices;

·             our expectations regarding the ability of our marketing programs or campaigns to stimulate additional purchases or to maximize product sales;

·             our belief that the use of extranets has the potential to yield additional sales opportunities and the ability to reach new customer bases;

·             our ability to limit risk related to price reductions;

·             our belief regarding the effect of seasonal trends and general economic conditions on our business and results of operations across all of our segments;

·             our expectations regarding competition and the industry trend toward consolidation;

·             our expectations regarding the payment of dividends and our intention to retain any earnings to finance the growth and development of our business;

 

25



 

·             our compliance with laws and regulations;

·             our beliefs regarding the applicability of tax regulations;

·             our expectations regarding the impact of accounting pronouncements;

·             our belief regarding financing of repurchases of our common stock;

·             our belief that backlog is not useful for predicting our future sales;

·             our belief that our existing distribution facilities are adequate for our current and foreseeable future needs; and

·             the likelihood that new laws and regulations will be adopted with respect to the Internet, privacy and data security that may impose additional restrictions or burdens on our business.

 

Forward-looking statements involve certain risks and uncertainties, and actual results may differ materially from those discussed in any such statement. Factors that could cause actual results to differ materially from such forward-looking statements include the risks described in greater detail under the heading “Risk Factors” in Part II, Item 1A of this report. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and, except as otherwise required by law, we assume no obligation to update or revise any forward-looking statement or other information contained herein to reflect new information, events or circumstances after the date hereof.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our financial instruments include cash and cash equivalents and long-term debt. At June 30, 2011, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.

 

We have not entered into derivative financial instruments as of June 30, 2011. However, from time-to-time, we contemplate and may enter into derivative financial instruments related to interest rate, foreign currency, and other market risks.

 

Interest Rate Risk

 

We have exposure to the risks of fluctuating interest rates on our line of credit and notes payable. The variable interest rates on our line of credit and notes payable are tied to the prime rate or the LIBOR, at our discretion. At June 30, 2011, we had $56.4 million outstanding under our line of credit and $9.9 million outstanding under our notes payable. As of June 30, 2011, the hypothetical impact of a one percentage point increase in interest rate related to the outstanding borrowings under our line of credit and notes payable would be to increase our annual interest expense by approximately $0.7 million.

 

Foreign Currency Exchange Risk

 

We have operation centers in Canada and the Philippines that provide back-office administrative support and customer service support. In each of these countries, transactions are primarily conducted in the respective local currencies. In addition, our two foreign subsidiaries that operate the operation centers have intercompany accounts with our U.S. subsidiaries that eliminate upon consolidation. However, transactions resulting in such accounts expose us to foreign currency rate fluctuations. We record gains and losses resulting from exchange rate fluctuations on our short-term intercompany accounts in “Selling, general and administrative expenses” in our Consolidated Statements of Operations and translation gains and losses resulting from exchange rate fluctuations on local currency based assets and liabilities in “Accumulated other comprehensive income (loss),” a separate component of stockholders’ equity on our Consolidated Balance Sheets. As such, we have foreign currency translation exposure for changes in exchange rates for these currencies. As of June 30, 2011, we did not have material foreign currency or overall currency exposure. Significant changes in exchange rates between foreign currencies in which we transact business and the U.S. dollar may adversely affect our Consolidated Statements of Operations and Consolidated Balance Sheets.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2011.

 

26



 

Changes in Internal Control Over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the second quarter of 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not currently a party to any legal proceedings with loss contingencies, which are expected to be material. From time to time, we receive claims of and become subject to consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Any such litigation could result in a material amount of legal or related expenses and be time consuming and could divert our management and key personnel from our business operations. In connection with any such litigation, we may be subject to significant damages or equitable remedies relating to the operation of our business. Any such litigation may materially harm our business, results of operations and financial condition.

 

ITEM 1A. RISK FACTORS

 

This report and other documents we file with the Securities and Exchange Commission contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business, our beliefs and our management’s assumptions. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. You should carefully consider the risks and uncertainties facing our business which are set forth below. The risks described below are not the only ones facing us. Our business is also subject to risks that affect many other companies, such as employment relations, general economic conditions, geopolitical events and international operations. Further, additional risks not currently known to us or that we currently believe are immaterial also may impair our business, operations, liquidity and stock price materially and adversely.

 

Our success is in part dependent on the accuracy and proper utilization of our management information systems.

 

We have committed significant resources to the development of sophisticated computer systems that are used to manage our business. Our computer systems support phone and web-based sales, marketing, purchasing, accounting, customer service, warehousing and distribution, and facilitate the preparation of daily operating control reports which are designed to provide concise and timely information regarding key aspects of our business. The systems allow us to, among other things, monitor sales trends, make informed purchasing decisions, and provide product availability and order status information. In addition to the main computer systems, we have systems of networked personal computers across all of our U.S. and foreign locations. We also use our management information systems to manage our inventory. We believe that in order to remain competitive, we will need to upgrade our management information systems on a regular basis, which could require significant capital expenditures.

 

We are currently upgrading many of our IT systems. We have purchased licenses for Microsoft Dynamics AX (Axapta) and other related tools, such as workflow software, web development tools and other related items, to upgrade our ERP and eCommerce systems. We initiated the implementation and upgrade of our eCommerce system in the second half of 2008 and have completed and launched a new generation of our public sites at macmall.com, onsale.com and pcmall.com. We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features, and we expect to be complete with all phases of the implementation of the ERP systems by 2013.

 

In addition to the upgrades to our IT systems, in July 2008, we entered into an agreement with Cisco Systems for the purchase and implementation of various solutions to upgrade our current infrastructure for a total cost of approximately $4.6 million. The purchase is financed through a capital lease over a five year term. We believe these upgrades have provided us with a unified platform for our entire company and a robust and efficient contact center. We completed the implementation of the Cisco solution across all of our locations in the second quarter of 2011.

 

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Our success is dependent on the accuracy and proper utilization of our management information systems and our telephone system. In addition to the costs associated with system upgrades, the transition to and implementation of new or upgraded systems can result in system delays or failures. We currently operate one of our management information systems using an HP3000 Enterprise System, which was supported by HP until December 2010. We have had a contract for the last three years with a third party service provider, who specializes in maintenance and support of both hardware and operating system, to provide us adequate support until the completion of the upgrade of our management information system, which is expected to be completed by 2012.

 

In addition to the specifically discussed IT and phone system upgrades discussed above, we also regularly upgrade our systems in an effort to better meet the information requirements of our users, and believe that to remain competitive, it will be necessary for us to upgrade our management information systems on a regular basis in the future. The implementation of any upgrades is complex, in part, because of the wide range of processes and the multiple systems that may need to be integrated across our business. In connection with any such upgrades we generally create a project plan to provide a reasonable allocation of resources to the project; however, execution of any such plan, or a divergence from it, may result in cost overruns, project delays or business interruptions. Furthermore, any divergence from any such project plan could affect the timing or the extent of benefits we may expect to achieve from the system or any process efficiencies.

 

Any disruptions, delays or deficiencies in the design or implementation of our IT systems, or in the performance of our legacy systems, particularly any disruptions, delays or deficiencies that impact our operations, could adversely affect our ability to effectively run and manage our business, including our ability to receive, process, ship and bill for orders in a timely manner. We do not currently have a redundant or back-up telephone system, nor do we have complete redundancy for our management information systems. Any interruption, corruption, deficiency or delay in our management information systems, including those caused by natural disasters, could have a material adverse effect on our business, financial condition and results of operations.

 

Changes and uncertainties in the economic climate could negatively affect the rate of information technology spending by our customers, which would likely have an impact on our business.

 

An important element of our business strategy is to increasingly focus on SMB, MME and Public Sector sales. As a result of the ongoing economic uncertainties, the direction and relative strength of the U.S. economy remains a considerable risk to our business, operating results and financial condition. This economic uncertainty could also increase the risk of uncollectible accounts receivable from our customers. During the recent economic downturns in the U.S. and elsewhere, SMB, MME and Public Sector entities generally reduced, often substantially, their rate of information technology spending. Additionally, these recent weak economic conditions and consumer confidence resulted in a decline in consumer spending on technology and related consumer goods. Future changes and uncertainties in the economic climate in the U.S. and elsewhere could have a similar negative impact on the rate of information technology spending of our current and potential customers, which would likely have a negative impact on our business, operating results and financial condition, and could significantly hinder our growth.

 

Our earnings and growth rate could be adversely affected by negative changes in economic or geopolitical conditions.

 

We are subject to risks arising from adverse changes in domestic and global economic conditions and unstable geopolitical conditions. If economic growth in the United States and other countries’ economies slows or declines, consumer and business spending rates could be significantly reduced. This could result in reductions in sales of our products, longer sales and payment cycles, slower adoption of new technologies and increased price competition, any of which could materially and adversely affect our business, results of operations and financial condition. Weak general economic conditions or uncertainties in geopolitical conditions, such as those currently occurring for example in the Middle East, could adversely impact our revenue, expenses and growth rate. In addition, our revenue, gross margins and earnings could deteriorate in the future as a result of unfavorable economic or geopolitical conditions.

 

Our revenue is dependent on sales of products from a small number of key manufacturers, and a decline in sales of products from these manufacturers could materially harm our business.

 

Our revenue is dependent on sales of products from a small number of key manufacturers and software publishers, including Apple, HP, IBM, Lenovo, Microsoft and Sony. For example, products manufactured by Apple represented approximately 21% and 16% of our net sales in the three months ended June 30, 2011 and 2010, and 22% and 16% of our net sales in the six months ended June 30, 2011 and 2010. Products manufactured by HP represented 22% and 25% of our net sales in the three months ended June 30, 2011 and 2010, and 21% and 22% of our net sales in the six months ended June 30, 2011 and 2010. A decline in sales of any of our key manufacturers’ products, whether due to decreases in supply of or demand for their products, termination of any of our agreements with them, or otherwise, could have a material adverse impact on our sales and operating results.

 

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Certain of our vendors provide us with incentives and other assistance that reduce our operating costs, and any decline in these incentives and other assistance could materially harm our operating results.

 

Certain of our vendors, including Adobe, Apple, Cisco, HP, IBM, Ingram Micro, Lenovo, Microsoft, Sony, Sun Microsystems and Tech Data, provide us with trade credit or substantial incentives in the form of discounts, credits and cooperative advertising. We have agreements with many of our vendors under which they provide us, or they have otherwise consistently provided us, with market development funds to finance portions of our catalog publication and distribution costs based upon the amount of coverage we give to their respective products in our catalogs or other advertising mediums. Any termination or interruption of our relationships with one or more of these vendors, particularly Apple or HP, or modification of the terms or discontinuance of our agreements and market development fund programs and arrangements with these vendors, could adversely affect our operating income and cash flow. For example, the amount of vendor consideration we receive from a particular vendor may be impacted by a number of events outside of our control, including acquisitions, management changes or economic pressures affecting such vendor, any of which could materially affect the amount of vendor consideration we receive from such vendor.

 

We do not have long-term supply agreements or guaranteed price or delivery arrangements with our vendors.

 

In most cases we have no guaranteed price or delivery arrangements with our vendors. As a result, we have experienced and may in the future experience inventory shortages on certain products. Furthermore, our industry occasionally experiences significant product supply shortages and customer order backlogs due to the inability of certain manufacturers to supply certain products as needed. We cannot assure you that suppliers will maintain an adequate supply of products to fulfill our orders on a timely basis, or at all, or that we will be able to obtain particular products on favorable terms or at all. Additionally, we cannot assure you that product lines currently offered by suppliers will continue to be available to us. A decline in the supply or continued availability of the products of our vendors, or a significant increase in the price of those products, could reduce our sales and negatively affect our operating results.

 

Substantially all of our agreements with vendors are terminable within 30 days.

 

Substantially all of our agreements with vendors are terminable upon 30 days’ notice or less. For example, while we are an authorized dealer for the full retail line of HP and Apple products, HP and Apple can terminate our dealer agreements upon 30 days’ notice. Vendors that currently sell their products through us could decide to sell, or increase their sales of, their products directly or through other resellers or channels. Any termination, interruption or adverse modification of our relationship with a key vendor or a significant number of other vendors would likely adversely affect our operating income, cash flow and future prospects.

 

Our success is dependent in part upon the ability of our vendors to develop and market products that meet changes in marketplace demand, as well as our ability to sell popular products from new vendors.

 

The products we sell are generally subject to rapid technological change and related changes in marketplace demand. Our success is dependent in part upon the ability of our vendors to develop and market products that meet these changes in marketplace demand. Our success is also dependent on our ability to develop relationships with and sell products from new vendors that address these changes in marketplace demand. To the extent products that address changes in marketplace demand are not available to us, or are not available to us in sufficient quantities or on acceptable terms, we could encounter increased price and other competition, which would likely adversely affect our business, financial condition and results of operations.

 

We may not be able to maintain existing or build new vendor relationships, which may affect our ability to offer a broad selection of products at competitive prices and negatively impact our results of operations.

 

We purchase products for resale both directly from manufacturers and indirectly through distributors and other sources, all of whom we consider our vendors. We also maintain certain qualifications and preferred provider status with several of our vendors, which provides us with preferred pricing, vendor training and support, preferred access to products, and other significant benefits. While these vendor relationships are an important element of our business, we do not have long-term agreements with any of these vendors. Any agreements with vendors governing our purchase of products are generally terminable by either party upon 30 days’ notice or less. In general, we agree to offer products through our catalogs and on our websites and the vendors agree to provide us with information about their products and honor our customer service policies. If we do not maintain our existing relationships or build new relationships with vendors on acceptable terms, including favorable product pricing and vendor consideration, we may not be able to offer a broad selection of products or continue to offer products at competitive prices. In addition, some vendors may decide not to offer particular products for sale on the Internet, and others may avoid offering their new products to retailers offering a mix of close-out and refurbished products in addition to new products. From time to time, vendors may be acquired by other companies, terminate our right to sell some or all of their products, modify or terminate our preferred provider or qualification status, change the applicable terms and conditions of sale or reduce or discontinue the incentives or vendor consideration that they offer us. Any such termination or the implementation of such changes, or our failure to build new vendor relationships, could have a negative impact on our operating results. Additionally, some products are subject to manufacturer or distributor allocation, which limits the number of units of those products that are available to us and may adversely affect our operating results.

 

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Our narrow gross margins magnify the impact of variations in our operating costs and of adverse or unforeseen events on our operating results.

 

We are subject to intense price competition with respect to the products we sell. As a result, our gross margins have historically been narrow, and we expect them to continue to be narrow. As a result of the recent economic downturn, we have experienced increasing price competition, which has had a negative impact on our gross margins. Our narrow gross margins magnify the impact of variations in our operating costs and of adverse or unforeseen events on our operating results. Future increases in costs such as the cost of merchandise, wage levels, shipping rates, freight costs and fuel costs may negatively impact our margins and profitability. We are not always able to raise the sales price of our merchandise to offset cost increases. If we are unable to maintain our gross margins in the future, it could have a material adverse effect on our business, financial condition and results of operations. In addition, because price is an important competitive factor in our industry, we cannot assure you that we will not be subject to increased price competition in the future. If we become subject to increased price competition in the future, we cannot assure you that we will not lose market share, that we will not be forced to reduce our prices and further reduce our gross margins, or that we will be able to compete effectively.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors.

 

We experience variability in our net sales and net income on a quarterly basis as a result of many factors.  These factors include:

 

·                  the general economic environment and competitive conditions, such as pricing;

·                  the timing of procurement cycles by our business, government and educational institution customers;

·                  seasonality in consumer spending;

·                  the frequency of our catalog mailings, introduction or discontinuation of new catalogs;

·                  variability in vendor programs;

·                  the introduction of new products or services by us and our competitors;

·                  changes in prices from our suppliers;

·                  promotions;

·                  the loss or consolidation of significant suppliers or customers;

·                  our ability to control costs;

·                  the timing of our capital expenditures;

·                  the condition of our industry in general;

·                  seasonal shifts in demand for computer and electronics products;

·                  consumer acceptance of new purchasing models such as our OnSale daily deals offering and the use of social commerce to drive sales;

·                  industry announcements and market acceptance of new products or upgrades;

·                  deferral of customer orders in anticipation of new product applications;

·                  product enhancements or operating systems;

·                  the relative mix of products sold during the period;

·                  any inability on our part to obtain adequate quantities of products carried in our catalogs;

·                  delays in the release by suppliers of new products and inventory adjustments;

·                  our expenditures on new business ventures and acquisitions;

·                  performance of acquired businesses;

·                  adverse weather conditions that affect response;

·                  distribution or shipping to our customers; and

·                  geopolitical events.

 

Our planned operating expenditures each quarter are based on sales forecasts for the quarter. If our sales do not meet expectations in any given quarter, our operating results for the quarter may be materially adversely affected. Our narrow gross margins may magnify the impact of these factors on our operating results. We believe that period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. In addition, our results in any quarterly period are not necessarily indicative of results to be expected for a full fiscal year. In future quarters, our operating results may be below the expectations of public market analysts or investors and as a result the market price of our common stock could be materially adversely affected.

 

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The transition of our business strategy to increasingly focus on SMB, MME and Public Sector sales presents numerous risks and challenges, and may not improve our profitability or result in expanded market share.

 

An important element of our business strategy is to increasingly focus on SMB, MME and Public Sector sales. In shifting our focus, we face numerous risks and challenges, including competition from a wider range of sources and an increased need to develop strategic relationships. We cannot assure you that our increased focus on SMB, MME and Public Sector sales will result in expanded market share or increased profitability. Furthermore, revenue from our public sector business is derived from sales to federal, state and local governmental departments and agencies, as well as to educational institutions, through various contracts and open market sales. Government contracting is a highly regulated area, and noncompliance with government procurement regulations or contract provisions could result in civil, criminal, and administrative liability, including substantial monetary fines or damages, termination of government contracts, and suspension, debarment or ineligibility from doing business with the government. The effect of any of these possible actions by any governmental department or agency with which we contract could adversely affect our business and results of operations. Moreover, contracting with governmental departments and agencies involves additional risks, such as longer payment terms, limited recourse against the government agency in the event of a business dispute, the potential lack of a limitation of our liability for damages from our provision of services to the department or agency, and the potential for changes in statutory or regulatory provisions that negatively affect the profitability of such contracts.

 

Our investments in our outbound phone-based sales force model may not improve our profitability or result in expanded market share.

 

We have made and are currently making efforts to increase our market share by investing in training and retention of our outbound phone-based sales force. We have also incurred, and expect to continue to incur, significant expenses resulting from infrastructure investments related to our outbound phone-based sales force. We cannot assure you that any of our investments in our outbound phone-based sales force will result in expanded market share or increased profitability in the near or long term.

 

Our financial performance could be adversely affected if we are not able to retain and increase the experience of our sales force or if we are not able to maintain or increase their productivity.

 

Our sales and operating results may be adversely affected if we are unable to increase the average tenure of our account executives or if the sales volumes and profitability achieved by our account executives do not increase with their increased experience.

 

Existing or future government and tax regulations could expose us to liabilities or costly changes in our business operations, and could reduce demand for our products and services.

 

Based upon current interpretations of existing law, certain of our subsidiaries currently collect and remit sales or use tax only on sales of products or services to residents of the states in which the respective subsidiaries have a physical presence or have voluntarily registered for sales tax collection. The U.S. Supreme Court has ruled that states, absent Congressional legislation, may not impose tax collection obligations on an out-of-state direct marketer whose only contacts with the taxing state are distribution of catalogs and other advertisement materials through the mail, and whose subsequent delivery of purchased goods is by mail or interstate common carriers. However, we cannot predict the level of contact with any state which would give rise to future or past tax collection obligations. Additionally, it is possible that federal legislation could be enacted that would permit states to impose sales or use tax collection obligations on out-of-state direct marketers. Furthermore, court cases have upheld tax collection obligations on companies, including mail order companies, whose contacts with the taxing state were quite limited (e.g., visiting the state several times a year to aid customers or to inspect stores stocking their goods or to provide training or other support to customers in the state). States have also successfully imposed sales and use tax collection responsibility upon in-state manufacturers that agree to act as a drop shipper for the out-of-state marketer, giving rise to the risk that such taxes may be imposed indirectly on the out-of-state seller. We believe our operations in states in which we have no physical presence are different from the operations of the companies in those cases and are thus not subject to the tax collection obligations imposed by those decisions. Various state laws, regulations and taxing authorities have sought to impose on direct marketers with no physical presence in the taxing state the burden of collecting or reporting information related to state sales and use taxes on the sale of products shipped or services sold to those states’ residents, and it is possible that such a requirement could be imposed in the future. For example, New York recently adopted an affiliate marketing statute and related regulations that impose sales and use tax collection obligations on out-of-state sellers that use certain web-based affiliate marketing relationships with web-based affiliates deemed to be located in New York. Other states have proposed similar legislation. There can be no assurance that existing or future laws that impose taxes or other regulations on direct marketing or Internet commerce would not substantially impair our growth or otherwise have a material adverse effect on our business, results or operations and financial condition.

 

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In addition, we and our subsidiaries may be subject to state or local taxes on income or (in states such as Kentucky, Michigan, Ohio, Texas or Washington) on gross receipts or a similar measure earned in a state even though we and our subsidiaries may have no physical presence in the state. State and local governments may seek to impose such taxes in cases where they believe the taxpayer may have a significant economic presence by reason of significant sales to customers located in the states. The responsibility to pay income and gross receipts taxes has also been the subject of court actions and various legislative efforts. There can be no assurance that these taxes will not be imposed upon us and our subsidiaries.

 

We also are subject to general business laws and regulations, as well as laws and regulations specifically governing companies that do business over the Internet. These laws and regulations may cover taxation of eCommerce, user privacy, marketing and promotional practices (including electronic communications with our customers and potential customers), database protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, product safety, the provision of online payment services, copyrights, patents and other intellectual property rights, data security, unauthorized access (including the Computer Fraud and Abuse Act), and the characteristics and quality of products and services. Additionally, some of our subsidiaries which are government contractors or subcontractors are subject to laws and regulations of the federal government related to companies that sell to the federal government, including but not limited to regulations of the Department of Labor and laws and regulations related to our procurement of products and services and our sales to the government.

 

While we have sought to implement processes, programs and systems in an effort to achieve compliance w