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, 2014

 

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

 

PCM, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4518700

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

1940 E. Mariposa Avenue

El Segundo, California 90245

(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 x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

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 5, 2014, the registrant had 12,376,236 shares of common stock outstanding.

 

 

 



 

PCM, INC.

 

TABLE OF CONTENTS

 

 

 

Page

PART I - FINANCIAL INFORMATION (unaudited)

 

 

 

 

 

Item 1. Financial Statements

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013

 

2

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013

 

3

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2014 and 2013

 

4

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013

 

5

 

 

 

 

 

Notes to the Condensed Consolidated Financial Statements

 

6

 

 

 

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

 

13

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

27

 

 

 

Item 4. Controls and Procedures

 

28

 

 

 

PART II - OTHER INFORMATION (unaudited)

 

 

 

 

 

Item 1. Legal Proceedings

 

29

 

 

 

Item 1A. Risk Factors

 

29

 

 

 

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

 

44

 

 

 

Item 5. Other Information

 

45

 

 

 

Item 6. Exhibits

 

45

 

 

 

Signature

 

46

 



 

PCM, INC.

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

CONDENSED CONSOLIDATED BALANCE SHEETS

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

 

 

 

June 30,
2014

 

December 31,
2013

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,669

 

$

9,992

 

Accounts receivable, net of allowances of $566 and $1,408

 

173,095

 

195,805

 

Inventories

 

49,470

 

115,261

 

Prepaid expenses and other current assets

 

30,523

 

14,893

 

Deferred income taxes

 

2,424

 

2,583

 

Current assets of discontinued operations

 

277

 

1,973

 

Total current assets

 

262,458

 

340,507

 

Property and equipment, net

 

70,134

 

55,840

 

Deferred income taxes

 

135

 

225

 

Goodwill

 

25,510

 

25,510

 

Intangible assets, net

 

4,513

 

4,684

 

Other assets

 

4,612

 

6,808

 

Non-current assets of discontinued operations

 

14

 

1,248

 

Total assets

 

$

367,376

 

$

434,822

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

95,524

 

$

130,899

 

Accrued expenses and other current liabilities

 

27,718

 

29,204

 

Deferred revenue

 

20,119

 

9,427

 

Line of credit

 

52,652

 

110,499

 

Notes payable — current

 

2,906

 

1,167

 

Current liabilities of discontinued operations

 

981

 

1,716

 

Total current liabilities

 

199,900

 

282,912

 

Notes payable and other long-term liabilities

 

26,657

 

18,247

 

Deferred income taxes

 

7,599

 

7,901

 

Total liabilities

 

234,156

 

309,060

 

Commitments and contingencies

 

 

 

 

 

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; 15,674,622 and 15,053,067 shares issued; and 12,369,363 and 11,790,674 shares outstanding

 

16

 

15

 

Additional paid-in capital

 

119,677

 

115,801

 

Treasury stock, at cost: 3,305,259 and 3,262,393 shares

 

(15,751

)

(15,321

)

Accumulated other comprehensive income

 

1,794

 

1,816

 

Retained earnings

 

27,484

 

23,451

 

Total stockholders’ equity

 

133,220

 

125,762

 

Total liabilities and stockholders’ equity

 

$

367,376

 

$

434,822

 

 

See Notes to the Condensed Consolidated Financial Statements.

 

2



 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net sales

 

$

339,624

 

$

355,497

 

$

670,346

 

$

678,107

 

Cost of goods sold

 

290,985

 

305,463

 

572,189

 

582,705

 

Gross profit

 

48,639

 

50,034

 

98,157

 

95,402

 

Selling, general and administrative expenses

 

44,758

 

43,379

 

88,168

 

85,572

 

Operating profit

 

3,881

 

6,655

 

9,989

 

9,830

 

Interest expense, net

 

750

 

781

 

1,693

 

1,553

 

Income from continuing operations before income taxes

 

3,131

 

5,874

 

8,296

 

8,277

 

Income tax expense

 

1,293

 

2,502

 

3,430

 

3,496

 

Income from continuing operations

 

1,838

 

3,372

 

4,866

 

4,781

 

Loss from discontinued operations, net of taxes

 

(692

)

(209

)

(833

)

(382

)

Net income

 

$

1,146

 

$

3,163

 

$

4,033

 

$

4,399

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted Earnings Per Common Share

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.15

 

$

0.30

 

$

0.40

 

$

0.41

 

Loss from discontinued operations, net of taxes

 

(0.06

)

(0.02

)

(0.07

)

(0.03

)

Net income

 

0.09

 

0.28

 

0.33

 

0.38

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.14

 

$

0.29

 

$

0.37

 

$

0.40

 

Loss from discontinued operations, net of taxes

 

(0.05

)

(0.02

)

(0.06

)

(0.03

)

Net income

 

0.09

 

0.27

 

0.31

 

0.37

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

12,343

 

11,488

 

12,137

 

11,483

 

Diluted

 

12,945

 

11,771

 

12,841

 

11,734

 

 

See Notes to the Condensed Consolidated Financial Statements.

 

3



 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited, in thousands)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30

 

 

 

2014

 

2013

 

2014

 

2013

 

Net income

 

$

1,146

 

$

3,163

 

$

4,033

 

$

4,399

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

357

 

(346

)

(22

)

(579

)

Total other comprehensive (loss) income

 

357

 

(346

)

(22

)

(579

)

Comprehensive income

 

$

1,503

 

$

2,817

 

$

4,011

 

$

3,820

 

 

See Notes to the Condensed Consolidated Financial Statements.

 

4



 

PCM, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2014

 

2013

 

Cash Flows From Operating Activities

 

 

 

 

 

Net income

 

$

4,033

 

$

4,399

 

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

 

 

 

 

 

Depreciation and amortization

 

6,485

 

5,897

 

Provision for deferred income taxes

 

379

 

726

 

Excess tax benefit related to stock option exercises

 

(269

)

(37

)

Non-cash stock-based compensation

 

635

 

783

 

Change in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

22,872

 

(27,282

)

Inventories

 

67,326

 

1,607

 

Prepaid expenses and other current assets

 

(15,661

)

(8,532

)

Other assets

 

2,256

 

(1,816

)

Accounts payable

 

(37,623

)

410

 

Accrued expenses and other current liabilities

 

445

 

(717

)

Deferred revenue

 

10,676

 

14,204

 

Total adjustments

 

57,521

 

(14,757

)

Net cash provided by (used in) operating activities

 

61,554

 

(10,358

)

Cash Flows From Investing Activities

 

 

 

 

 

Purchases of property and equipment

 

(18,432

)

(7,447

)

Net cash used in investing activities

 

(18,432

)

(7,447

)

Cash Flows From Financing Activities

 

 

 

 

 

Net (payments) borrowings under line of credit

 

(57,847

)

12,766

 

Capital lease proceeds

 

 

206

 

Borrowing under note payable

 

9,060

 

4,108

 

Payments under notes payable

 

(714

)

(458

)

Change in book overdraft

 

1,421

 

8,722

 

Payments of obligations under capital lease

 

(1,421

)

(1,431

)

Net proceeds from stock issued under stock option plans

 

3,242

 

1,399

 

Payment for deferred financing costs

 

(30

)

(752

)

Common shares repurchased and held in treasury

 

(430

)

(1,558

)

Excess tax benefit related to stock option exercises

 

269

 

37

 

Net cash (used in) provided by financing activities

 

(46,450

)

23,039

 

Effect of foreign currency on cash flow

 

5

 

(391

)

Net change in cash and cash equivalents

 

(3,323

)

4,843

 

Cash and cash equivalents at beginning of the period

 

9,992

 

6,535

 

Cash and cash equivalents at end of the period

 

$

6,669

 

$

11,378

 

Supplemental Cash Flow Information

 

 

 

 

 

Interest paid

 

$

1,819

 

$

1,393

 

Income taxes paid

 

5,688

 

1,820

 

Supplemental Non-Cash Investing and Financing Activities

 

 

 

 

 

Purchase of property and equipment

 

$

979

 

$

270

 

Deferred financing costs

 

 

228

 

 

 See Notes to the Condensed Consolidated Financial Statements.

 

5



 

PCM, INC.

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Basis of Presentation and Description of Company

 

PCM, Inc. is a leading multi-vendor provider of technology products, services and solutions offered through our dedicated sales force and field service teams, direct marketing channels and a limited number of retail stores. Since our founding in 1987, we have served our customers by offering products and services purchased from vendors such as Apple, Cisco, Dell, HP, Ingram Micro, Lenovo, Microsoft and Tech Data. We add additional value by incorporating products and services into comprehensive solutions. Our sales and marketing efforts allow our vendor partners to reach multiple customer segments including commercial businesses, state, local and federal governments, educational institutions and individual consumers.

 

We have prepared the unaudited condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in conformity with accounting principles generally accepted in the United States of America, or GAAP, which requires us to make estimates and assumptions that affect amounts reported herein. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, our actual results reported in future periods may be affected by changes in those estimates. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations for interim financial reporting. In the opinion of management, all adjustments, consisting only of normal recurring items which are necessary for a fair presentation, have been included. The results for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013 and our Quarterly Report on Form 10-Q for the period ended March 31, 2014 filed with the SEC on March 14, 2014 and May 1, 2014.

 

We operate under three reportable operating segments - Commercial, Public Sector and MacMall. Our segments are primarily aligned based upon their respective customer base. We include corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments in Corporate & Other.

 

During the second quarter of 2014, we discontinued the operation of two of our retail stores, located in Huntington Beach, California and Chicago, Illinois and our OnSale and eCost businesses. We reflected the results of these operations, which were reported as a part of our MacMall segment, as discontinued operations for all periods presented herein on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations. See Note 3 below for more information.

 

We sell primarily to customers in the United States, and maintain offices throughout the United States, as well as in Montreal, Canada and Manila, Philippines. In the three months ended June 30, 2014, we generated approximately 75% of our revenue in our Commercial segment, 15% of our revenue in our Public Sector segment and 10% of our revenue in our MacMall segment. In the six months ended June 30, 2014, we generated approximately 76% of our revenue in our Commercial segment, 13% of our revenue in our Public Sector segment and 11% of our revenue in our MacMall segment.

 

Our Commercial segment sells complex products, services and solutions to commercial businesses in the United States, using multiple sales channels, including a field relationship-based selling model, an outbound phone based sales force, a field services organization and an online extranet.

 

Our Public Sector segment consists of sales made primarily to federal, state and local governments, as well as educational institutions. The Public Sector segment utilizes an outbound phone and field relationship-based selling model, as well as contract and bid business development teams and an online extranet.

 

Our MacMall segment consists of sales made via telephone, the Internet and two retail stores to consumers, small businesses and creative professionals.

 

We have restated the consolidated statement of cash flows for the six months ended June 30, 2013 to increase purchases of property and equipment and borrowing under note payable by $1.7 million and decrease non-cash purchase of property and equipment by $1.7 million to correct an immaterial error from netting these amounts.

 

6



 

2. Summary of New Accounting Standards

 

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”), which provides a comprehensive guidance for revenue recognition. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle of the guidance provides that a company should recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, using either a full retrospective or modified retrospective method of adoption. We are currently evaluating the transition method we will adopt and the impact of the adoption of ASU 2014-09 on our consolidated financial statements.

 

In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which amended guidance on the presentation of financial statements and reporting discontinued operations and disclosures of disposals of components of an entity within property, plant and equipment. ASU 2014-08 amends the definition of a discontinued operation and requires entities to disclose additional information about disposal transactions that do not meet the discontinued-operations criteria. ASU 2014-08 is effective for disposals that occur in annual periods (and interim periods therein) beginning on or after December 15, 2014. We are currently evaluating the impact that ASU 2014-08 will have on our consolidated financial statements.

 

3. Discontinued Operations

 

During the second quarter of 2014, we discontinued the operation of two of our retail stores, located in Huntington Beach, California and Chicago, Illinois and our OnSale and eCost businesses. The financial results of these operations, which were historically reported as part of our MacMall segment, have been excluded from our results from continuing operations for all periods presented herein and have been presented as discontinued operations. The revenues, operating and non-operating results of the discontinued operations are reflected in a single line item entitled “Loss from discontinued operations, net of taxes” on our Condensed Consolidated Statements of Operations, and the related assets and liabilities are presented in our Condensed Consolidated Balance Sheets in line items entitled “Current assets of discontinued operations,” “Non-current assets of discontinued operations” and “Current liabilities of discontinued operations” for all periods presented herein.

 

The carrying amounts of major classes of assets and liabilities that have been included in such balance sheet line items, as described above, in our Condensed Consolidated Balance Sheets were as follows (in thousands):

 

 

 

June 30,
2014

 

December 31,
2013

 

Accounts receivable, net

 

$

111

 

$

273

 

Inventories, net

 

166

 

1,700

 

Current assets of discontinued operations

 

277

 

1,973

 

Fixed assets, net

 

 

768

 

Intangible assets, net

 

 

466

 

Other non-current assets

 

14

 

14

 

Non-current assets of discontinued operations

 

14

 

1,248

 

Total assets of discontinued operations

 

$

291

 

$

3,221

 

 

 

 

 

 

 

Accounts payable

 

$

191

 

$

130

 

Accrued expenses and other current liabilities

 

777

 

1,557

 

Deferred revenue

 

13

 

29

 

Current liabilities of discontinued operations

 

$

981

 

$

1,716

 

 

7



 

The operating results of our discontinued operations reported in “Loss from discontinued operations, net of taxes” in our Condensed Consolidated Statements of Operations were as follows (in thousands):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net sales

 

$

6,783

 

$

10,924

 

$

15,114

 

$

25,482

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

$

(1,179

)

$

(365

)

$

(1,421

)

$

(662

)

Income tax benefit

 

(487

)

(156

)

(588

)

(280

)

Loss from discontinued operations, net of taxes

 

$

(692

)

$

(209

)

$

(833

)

$

(382

)

 

4. Goodwill and Intangible Assets

 

Goodwill

 

There was no change in goodwill during the six months ended June 30, 2014. Goodwill totaled $25.5 million as of June 30, 2014 and December 31, 2013, all of which related to our Commercial 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, 2014

 

At December 31, 2013

 

 

 

Useful Lives
(years)

 

Gross
Amount

 

Accumulated
Amortization

 

Net
Amount

 

Gross
Amount

 

Accumulated
Amortization

 

Net
Amount

 

Patent, trademarks & URLs

 

12

 

$

3,286

(1)

$

288

 

$

2,998

 

$

3,286

(1)

$

271

 

$

3,015

 

Customer relationships

 

10

 

2,550

 

1,035

 

1,515

 

2,550

 

908

 

1,642

 

Non-compete agreements

 

4

 

 

 

 

250

 

223

 

27

 

Total intangible assets

 

 

 

$

5,836

 

$

1,323

 

$

4,513

 

$

6,086

 

$

1,402

 

$

4,684

 

 


(1)     Included in the gross amounts for “Patent, trademarks & URLs” at June 30, 2014 and December 31, 2013 are $2.9 million of trademarks with indefinite useful lives that are not amortized.

 

Amortization expense for intangible assets was approximately $0.1 million and $0.5 million for the three months ended June 30, 2014 and 2013 and $0.2 million and $0.9 million for the six months ended June 30, 2014 and 2013. Estimated amortization expense for intangible assets in each of the next five years and thereafter is as follows: $0.1 million in the remainder of 2014, $0.3 million in 2015, $0.3 million in 2016, $0.3 million in 2017, $0.3 million in 2018 and $0.4 million thereafter.

 

5. Line of Credit and Notes Payable

 

We maintain an asset-based revolving credit facility that provides for, among other things, (i) a credit limit of $200 million; (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 September 30, 2017. 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, and a portion of the value of certain real estate, 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.

 

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 1.0 to 1.0 calculated on a trailing four-quarter basis as of the end of the last quarter immediately preceding such FCCR triggering event date. At June 30, 2014, we were in compliance with our financial covenant under the credit facility.

 

8



 

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 our utilization of early-pay discounts. At June 30, 2014, we had $52.7 million of net working capital advances outstanding under the line of credit. At June 30, 2014, the maximum credit line was $200 million and we had $53.4 million available to borrow for working capital advances under the line of credit.

 

In connection with, and as part of, our revolving credit facility, we maintain a term note with a principal balance of $4.34 million, payable in equal monthly principal installments, amortized over 84 months, beginning on April 1, 2013, plus interest at the prime rate with a LIBOR option. In the event of a default, termination or non-renewal of the revolving credit facility upon the maturity thereof, the term loan is payable in its entirety upon demand by the lenders. At June 30, 2014, we had $3.6 million outstanding under the term note. The remaining balance of our term note matures as follows: $0.3 million in the reminder of 2014, $0.6 million annually in each of the years 2015 through 2018, and $0.8 million thereafter.

 

In May 2013, we completed the purchase of real property adjacent to the building we own in Santa Monica, California for $3.0 million and financed $1.7 million of the purchase price with a sub-line under our revolving credit facility. The loan bears the same interest terms as our revolving credit facility. However, the principal amount is amortized monthly over an 84 month period similar to our term note, with monthly principal amortization of approximately $24,000 beginning in July 2014. Accordingly, at June 30, 2014, $0.3 million and $1.4 million were included in our “Notes Payable — current” and “Notes payable and other long-term liabilities” on our Condensed Consolidated Balance Sheets.

 

In June 2011, we entered into a credit agreement to finance the acquisition and improvement of the real property we purchased in March 2011 in El Segundo, California. The credit agreement provides for a five year term and a 25 year straight-line, monthly 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, payable monthly. At June 30, 2014, we had $9.1 million outstanding under this credit agreement, which matures as follows: $0.2 million in the remainder of 2014, $0.4 million in 2015 and $8.5 million in 2016. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million and have incurred additional costs of $9.3 million through June 30, 2014 towards the construction of a new cloud data center that we opened in late June 2014. The Tier III facility is strategically located in a data center-centric development in New Albany, Ohio. The new facility complements our two existing data centers and a 24/7 Integrated Operations Center (IOC) located in Atlanta, Georgia, enhancing our managed service offerings, including cloud services, data center hosting and management, remote monitoring and disaster recovery. In July 2013, we entered into a loan agreement for up to $7.725 million to finance the build out of the new data center. The loan agreement provides for draws during a construction period subsequent to reaching certain expenditure thresholds. Any outstanding borrowing during the construction period will bear interest at the prime rate plus 0.25%, followed by a five year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity. Interest during the amortization period is variable, indexed to LIBOR plus a spread of 2.25%. At June 30, 2014, we had $4.3 million outstanding under this loan agreement.

 

At June 30, 2014, our effective weighted average annual interest rate on outstanding amounts under the credit facility, term note and notes payable was 2.1%.

 

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

 

We determine our interim income tax provision by estimating our effective income tax rate expected to be applicable for the full fiscal year.

 

Accounting for Uncertainty in Income Taxes

 

At June 30, 2014, we had no unrecognized tax positions. For the three months and six months ended June 30, 2014 and 2013, we did not recognize any interest or penalties for uncertain tax positions. There were also no accrued interest and penalties at June 30, 2014 and 2013. We do not anticipate any significant increases in our unrecognized tax benefits within the next twelve months. Further, since we did not have any unrecognized tax benefits at June 30, 2014, we do not anticipate any significant decreases within the next twelve months.

 

We are subject to U.S. and foreign income tax examinations for years subsequent to 2009, and state income tax examinations for years following 2008. However, to the extent allowable by law, the tax authorities may have a right to examine prior periods when net operating losses or tax credits were generated and carried forward for subsequent utilization, and make adjustments up to the amount of the net operating losses or credit carryforwards.

 

9



 

7. Stockholders’ Equity

 

In September 2012, our Board of Directors approved a $10 million increase to our discretionary stock repurchase program, which was originally adopted in October 2008 with an initial authorized maximum of $10 million. Under the program, the shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. We expect that the repurchase of our common stock under the program will be financed with existing working capital and amounts available under our existing credit facility. The repurchased shares are held as treasury stock. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted.

 

During the three months ended June 30, 2014, we repurchased a total of 42,866 shares of our common stock under this program for a total cost of approximately $0.4 million. From the inception of the program in October 2008 through June 30, 2014, we have repurchased an aggregate total of 2,888,581 shares of our common stock for a total cost of $14.7 million. The repurchased shares are held as treasury stock. At June 30, 2014, we had $5.3 million available in stock repurchases under the program, subject to any limitations that may apply from time to time under our existing credit facility.

 

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.

 

8. Earnings Per Share

 

Basic earnings per share (“EPS”) 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. Approximately 439,000 and 912,000 shares of common stock for the three months ended June 30, 2014 and 2013, and approximately 400,000 and 1,051,000 shares of common stock for the six months ended June 30, 2014 and 2013 underlying stock options 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, 2014:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Income from continuing operations

 

$

1,838

 

12,343

 

$

0.15

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

602

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted income from continuing operations

 

$

1,838

 

12,945

 

$

0.14

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2013:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Income from continuing operations

 

$

3,372

 

11,488

 

$

0.30

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

283

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted income from continuing operations

 

$

3,372

 

11,771

 

$

0.29

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2014:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Income from continuing operations

 

$

4,866

 

12,137

 

$

0.40

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

704

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted income from continuing operations

 

$

4,866

 

12,841

 

$

0.37

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2013:

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Income from continuing operations

 

$

4,781

 

11,483

 

$

0.41

 

Effect of dilutive securities

 

 

 

 

 

 

 

Dilutive effect of stock options

 

 

251

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Adjusted income from continuing operations

 

$

4,781

 

11,734

 

$

0.40

 

 

10



 

9. Segment Information

 

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

 

 

 

Commercial

 

Public
Sector

 

MacMall

 

Corporate &
Other

 

Consolidated

 

Three Months Ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

256,385

 

$

50,883

 

$

32,363

 

$

(7

)

$

339,624

 

Gross profit

 

39,804

 

5,262

 

3,581

 

(8

)

48,639

 

Depreciation and amortization expense(1)

 

603

 

13

 

67

 

2,038

 

2,721

 

Operating profit

 

14,215

 

2,046

 

274

 

(12,654

)

3,881

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

257,374

 

$

61,190

 

$

36,934

 

$

(1

)

$

355,497

 

Gross profit

 

40,375

 

5,313

 

4,513

 

(167

)

50,034

 

Depreciation and amortization expense(1)

 

1,015

 

14

 

30

 

1,689

 

2,748

 

Operating profit

 

16,989

 

1,757

 

1,032

 

(13,123

)

6,655

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

508,506

 

$

87,303

 

$

74,547

 

$

(10

)

$

670,346

 

Gross profit

 

81,338

 

8,804

 

8,026

 

(11

)

98,157

 

Depreciation and amortization expense(1)

 

1,215

 

26

 

99

 

3,964

 

5,304

 

Operating profit

 

31,873

 

2,620

 

1,076

 

(25,580

)

9,989

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

508,741

 

$

92,216

 

$

77,216

 

$

(66

)

$

678,107

 

Gross profit

 

78,271

 

8,208

 

8,938

 

(15

)

95,402

 

Depreciation and amortization expense(1)

 

2,060

 

29

 

59

 

3,380

 

5,528

 

Operating profit

 

31,756

 

1,881

 

1,755

 

(25,562

)

9,830

 

 


(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 & Other.

 

As of June 30, 2014 and December 31, 2013, we had total consolidated assets of $367.4 million and $434.8 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 $1.3 million and $1.4 million in the three month periods ended June 30, 2014 and 2013, respectively, and $2.6 million and $2.7 million in the six month periods ended June 30, 2014 and 2013. Some of our leases contain renewal options and escalation clauses, and require us to pay taxes, insurance and maintenance costs.

 

11



 

Legal Proceedings

 

We are not currently a party to any material legal proceedings, other than ordinary routine litigation incidental to the business. 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 be costly and 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.

 

11. Subsequent Event

 

On August 6, 2014, we entered into a definitive agreement for the sale of real property located in Santa Monica, California, upon which we currently operate one of our retail stores, for $20.2 million, subject to diligence and closing conditions. The property has a net book value of approximately $4.4 million. We intend to shut down the operations of this retail store upon consummation of the sale.

 

***

 

12



 

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 Part II, Item 1A and elsewhere in this report.

 

BUSINESS OVERVIEW

 

PCM, Inc. is a leading multi-vendor provider of technology products, services and solutions offered through our dedicated sales force and field service teams, direct marketing channels and a limited number of retail stores. Since our founding in 1987, we have served our customers by offering products and services purchased from vendors such as Apple, Cisco, Dell, HP, Ingram Micro, Lenovo, Microsoft and Tech Data. We add additional value by incorporating products and services into comprehensive solutions. Our sales and marketing efforts allow our vendor partners to reach multiple customer segments including commercial businesses, state, local and federal governments, educational institutions and individual consumers.

 

We operate under three reportable operating segments - Commercial, Public Sector and MacMall. Our segments are primarily aligned based upon their respective customer base. We include corporate related expenses such as legal, accounting, information technology, product management and other administrative costs that are not otherwise included in our reportable operating segments in Corporate & Other.

 

During the second quarter of 2014, we discontinued the operation of two of our retail stores, located in Huntington Beach, California and Chicago, Illinois and our OnSale and eCost businesses. We reflected the results of these operations, which were reported as a part of our MacMall segment, as discontinued operations for all periods presented herein on our Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations.

 

We sell primarily to customers in the United States, and maintain offices throughout the United States, as well as in Montreal, Canada and Manila, Philippines. In the three months ended June 30, 2014, we generated approximately 75% of our revenue in our Commercial segment, 15% of our revenue in our Public Sector segment and 10% of our revenue in our MacMall segment. In the six months ended June 30, 2014, we generated approximately 76% of our revenue in our Commercial segment, 13% of our revenue in our Public Sector segment and 11% of our revenue in our MacMall segment.

 

Our Commercial segment sells complex products, services and solutions to commercial businesses in the United States, using multiple sales channels, including a field relationship-based selling model, an outbound phone based sales force, a field services organization and an online extranet.

 

Our Public Sector segment consists of sales made primarily to federal, state and local governments, as well as educational institutions. The Public Sector segment utilizes an outbound phone and field relationship-based selling model, as well as contract and bid business development teams and an online extranet.

 

Our MacMall segment consists of sales made via telephone, the Internet and two retail stores to consumers, small businesses and creative professionals.

 

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 commercial customers 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”) space. 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. We may also experience variability in our gross profit and gross profit margin as a result of changes in the various vendor programs we participate in and its effect on the amount of vendor consideration we receive from a particular vendor, which may be impacted by a number of events outside of our control. 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.

 

13



 

A substantial portion of our business is dependent on sales of Apple, HP, and products purchased from other vendors including Cisco, Dell, Ingram Micro, Lenovo, Microsoft and Tech Data. Products manufactured by HP represented approximately 17% and 21% of our net sales in the three months ended June 30, 2014 and 2013, respectively, and products manufactured by Apple represented approximately 16% and 15% of our net sales in the three months ended June 30, 2014 and 2013, respectively. Products manufactured by HP represented approximately 19% and 21% of our net sales in the six months ended June 30, 2014 and 2013, respectively, and products manufactured by Apple represented approximately 17% of our net sales in each of the six months ended June 30, 2014 and 2013, respectively.

 

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.

 

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. The economic climate in the U.S. and elsewhere could have an impact on the rate of information technology spending of our current and potential customers, which would impact our business and results of operations. These factors affect sales of our products, sales cycles, adoption rates of new technologies and level of price competition. We continue to focus our efforts on cost controls, competitive pricing strategies, and driving higher margin service and solution sales. We also continue 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.

 

STRATEGIC DEVELOPMENTS

 

Real Estate Transactions

 

On August 6, 2014, we entered into a definitive agreement for the sale of real property located in Santa Monica, California, upon which we currently operate one of our retail stores, for $20.2 million, subject to diligence and closing conditions. The property has a net book value of approximately $4.4 million. We intend to shut down the operations of this retail store upon consummation of the sale. We also expect to effectuate a tax deferred exchange under Section 1031 of the Internal Revenue Code of 1986, as amended, through one or more purchases of real property to be used in connection with our company’s business and operations. We will evaluate potential exchanges and purchases, but would expect that any exchanges or purchases we make would benefit us through direct ownership of facilities that are strategic to our operations, reductions in our lease obligations, or other ancillary benefits. In conjunction with this transaction, we will be required to pay off our outstanding real estate related debt at the time of closing, which was $5.3 million as of June 30, 2014.

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million and have incurred additional costs of $9.3 million through June 30, 2014 towards the construction of a new cloud data center that we opened in late June 2014. The Tier III facility is strategically located in a data center-centric development in New Albany, Ohio. The new facility complements our two existing data centers and a 24/7 Integrated Operations Center (IOC) located in Atlanta, Georgia, enhancing our managed service offerings, including cloud services, data center hosting and management, remote monitoring and disaster recovery.

 

ERP and Web Infrastructure Upgrades

 

We are currently upgrading many of our IT systems. We have purchased licenses for Microsoft Dynamics AX and other related ISV (Independent Software Vendor) modules (Tax, EDI, Freight, Pricing and Rebates) to provide a complete and robust solution.  We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. While it is difficult to estimate costs and time frames for completion, based on the complexity of the systems design, customization and implementation and our current estimates, which are subject to change, we currently expect to incur a cost of approximately $24 million for the major phases of the ERP upgrade and to be complete with all major phases of the design, configuration and customization by the end of 2014. We expect to complete the implementation and migration of certain of the legacy systems to the new ERP solution by the end of 2015. To date, we have incurred approximately $21 million of such costs. In addition to the above expenditures, we expect to make periodic upgrades to our IT systems on an ongoing basis. As part of the upgrades to our IT systems, we recently upgraded our eCommerce systems and launched a new generation of our public website and extranet at pcm.com, macmall.com, and pcmg.com, which are included in the amounts above.  We also implemented various Cisco solutions to upgrade our communications infrastructure to provide a unified platform for our entire company and to provide a robust and efficient contact center.

 

14



 

Common Stock Repurchase Program

 

At June 30, 2014, we had $5.3 million available in stock repurchases under a discretionary stock repurchase program, subject to any limitations that may apply from time to time under our existing credit facility. Under the program, the shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted. During the three months ended June 30, 2014, we repurchased a total of 42,866 shares of our common stock under this program for a total cost of approximately $0.4 million. From the inception of the program in October 2008 through June 30, 2014, we have repurchased an aggregate total of 2,888,581 shares of our common stock for a total cost of $14.7 million. The repurchased shares are held as treasury stock.

 

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, 2013.

 

Revenue Recognition. We adhere to the guidelines and principles of sales recognition described in ASC 605 - 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 or 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.

 

We also sell certain products for which we act as an agent in accordance with ASC 605-45. Products in this category include the sale of third-party services, warranties, software assurance (“SA”) or subscriptions. SA is an “insurance” or “maintenance” product that allows customers to upgrade, at no additional cost, to the latest technology if new applications are introduced during the period that the SA is in effect. These sales do not meet the criteria for gross sales recognition, and thus are recognized on a net basis at the time of sale. Under net sales recognition, the cost paid to the vendor or third-party service provider is recorded as a reduction to sales, resulting in net sales being equal to the gross profit on the transaction.

 

Some of our larger customers are offered the opportunity by certain of our vendors to purchase software licenses and SA under enterprise agreements (“EAs”). Under EAs, customers are considered to be compliant with applicable license requirements for the ensuing year, regardless of changes to their employee base. Customers are charged an annual true-up fee for changes in the number of users over the year. With most EAs, our vendors will transfer the license and invoice the customer directly, paying us an agency fee or commission on these sales. We record these fees as a component of net sales as earned and there is no corresponding cost of sales amount. In certain instances, we invoice the customer directly under an EA and accounts for the individual items sold based on the nature of the item. Our vendors typically dictate how the EA will be sold to the customer.

 

15



 

When a customer order contains multiple deliverables 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. For arrangements with multiple units of accounting, arrangement consideration is allocated among the units of accounting, where separable, based on their relative selling price. Relative selling price is determined based on vendor-specific objective evidence, if it exists. Otherwise, third-party evidence of selling price is used, when it is available, and in circumstances when neither vendor-specific objective evidence nor third-party evidence of selling price is available, management’s best estimate of selling price is used.

 

Revenue from professional services is either recognized as incurred for services billed at an hourly rate or recognized using the proportional performance method for services provided at a fixed fee. Revenue for data center services, including internet connectivity, web hosting, server co-location and managed services, is recognized over the period the service is performed.

 

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, 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.

 

Inventory. Our inventories consist primarily of finished goods, and are stated at lower of cost or market, which is determined by general market conditions, nature, age and type of each product and assumptions about future demand.

 

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 Customer Payments and Incentives, since such funds are not a reimbursement of specific, incremental, identifiable costs incurred by us in selling the vendors’ products. 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 — Compensation — Stock Compensation. 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. We record compensation expense related to stock-based compensation over the award’s requisite service period on a straight-line basis.

 

We estimate the grant date fair value of each stock option grant awarded 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 use of accounting judgment and financial estimates. We compute the expected term assumption 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 is revised annually based upon the most updated forfeiture information at that time. 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 as of October 1, or sooner if an event occurs or circumstances change that would more likely than not result in an impairment loss.

 

16



 

Under ASC 350 — Intangibles — Goodwill and Other, 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 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. Goodwill is allocated to various reporting units, which are generally an operating segment or one level below the operating segment.

 

Goodwill impairment testing is a two-step process. Step one involves comparing the fair value of our reporting units to their carrying amount. If the fair value of the reporting unit is greater than its carrying amount, there is no impairment and no further testing is required. If the reporting unit’s carrying amount is greater than the fair value, the second step must be completed to measure the amount of impairment, if any. Step two calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible assets, excluding goodwill, of the reporting unit from the fair value of the reporting unit as determined in step one. The implied fair value of goodwill determined in this step is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.

 

We performed our annual impairment analysis of goodwill and indefinite-lived intangible assets for possible impairment as of October 1, 2013. Our management, with the assistance of an independent third-party valuation firm, determined the fair values of our reporting units and their underlying assets, and compared them to their respective carrying values. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. The carrying value of goodwill was allocated to our reporting units pursuant to ASC 350. As a result of our annual impairment analysis as of October 1, 2013, we have determined that no impairment of goodwill and other indefinite-lived intangible assets existed.

 

Fair value was determined by using a weighted combination of a market-based approach and an income approach, as this combination was deemed to be the most indicative of fair value in an orderly transaction between market participants. Under the market-based approach, we utilized information regarding our company and publicly available comparable company and industry information to determine cash flow multiples and revenue multiples that are used to value our reporting units. Under the income approach, we determined fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn.

 

In addition, fair value of our indefinite-lived trademark was determined using the relief from royalty method under the income approach to value. This method applies a market based royalty rate to projected revenues that are associated with the trademarks. Applying the royalty rate to projected revenues resulted in an indication of the pre-tax royalty savings associated with ownership of the trademarks.  Projected after-tax royalty savings were discounted to present value at the reporting unit’s weighted average cost of capital, and a tax amortization benefit (calculated based on a 15 year life for tax purposes) was added.

 

In conjunction with our annual assessment of goodwill, our valuation techniques did not indicate any impairment as of October 1, 2013. All reporting units with goodwill passed the first step of the goodwill evaluation, with the fair values of our Abreon and Commercial without Abreon reporting units exceeding their respective carrying values by 105% and 39% and, accordingly, we were not required to perform the second step of the goodwill evaluation. There is $7.2 million and $18.3 million of goodwill residing in our Abreon and Commercial without Abreon reporting units, respectively. In applying the market and income approaches to determining fair value of our reporting units, we rely on a number of significant assumptions and estimates including revenue growth rates and operating margins, discount rates and future market conditions, among others. Our estimates are based upon assumptions we believe to be reasonable, but which by nature are uncertain and unpredictable. Changes in one or more of these significant estimates or assumptions could affect the results of these impairment reviews.

 

As part of our annual review for impairment, we assessed the total fair values of the reporting units and compared total fair value to our market capitalization at October 1, 2013, including the implied control premium, to determine if the fair values are reasonable compared to external market indicators. When comparing our market capitalization to the discounted cash flow models for each reporting unit summed together, the implied control premium was approximately 31% as of October 1, 2013. We believe several factors contributed to our low market capitalization, including the lack of trading volume in our stock and the recent significant investments made in various parts of our business and their effects on analyst earnings models.

 

17



 

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 October 1, 2013 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 October 1, 2014 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.

 

RESULTS OF OPERATIONS

 

Consolidated Statements of Operations Data

 

The following table sets forth, for the periods indicated, our Condensed Consolidated Statements of Operations (in thousands, unaudited, except per share amounts) and information derived from our Condensed 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,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net sales

 

$

339,624

 

$

355,497

 

$

670,346

 

$

678,107

 

Cost of goods sold

 

290,985

 

305,463

 

572,189

 

582,705

 

Gross profit

 

48,639

 

50,034

 

98,157

 

95,402

 

Selling, general and administrative expenses

 

44,758

 

43,379

 

88,168

 

85,572

 

Operating profit

 

3,881

 

6,655

 

9,989

 

9,830

 

Interest expense, net

 

750

 

781

 

1,693

 

1,553

 

Income from continuing operations before income taxes

 

3,131

 

5,874

 

8,296

 

8,277

 

Income tax expense

 

1,293

 

2,502

 

3,430

 

3,496

 

Income from continuing operations

 

1,838

 

3,372

 

4,866

 

4,781

 

Loss from discontinued operations, net of taxes

 

(692

)

(209

)

(833

)

(382

)

Net income

 

$

1,146

 

$

3,163

 

$

4,033

 

$

4,399

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted Earnings Per Common Share

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.15

 

$

0.30

 

$

0.40

 

$

0.41

 

Loss from discontinued operations, net of taxes

 

(0.06

)

(0.02

)

(0.07

)

(0.03

)

Net income

 

0.09

 

0.28

 

0.33

 

0.38

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.14

 

$

0.29

 

$

0.37

 

$

0.40

 

Loss from discontinued operations, net of taxes

 

(0.05

)

(0.02

)

(0.06

)

(0.03

)

Net income

 

0.09

 

0.27

 

0.31

 

0.37

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

12,343

 

11,488

 

12,137

 

11,483

 

Diluted

 

12,945

 

11,771

 

12,841

 

11,734

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Net sales

 

100

%

100

%

100

%

100

%

Cost of goods sold

 

85.7

 

85.9

 

85.4

 

85.9

 

Gross profit

 

14.3

 

14.1

 

14.6

 

14.1

 

Selling, general and administrative expenses

 

13.2

 

12.2

 

13.1

 

12.7

 

Operating profit

 

1.1

 

1.9

 

1.5

 

1.4

 

Interest expense, net

 

0.2

 

0.2

 

0.3

 

0.2

 

Income from continuing operations before income taxes

 

0.9

 

1.7

 

1.2

 

1.2

 

Income tax expense

 

0.4

 

0.7

 

0.5

 

0.5

 

Income from continuing operations

 

0.5

 

1.0

 

0.7

 

0.7

 

Loss from discontinued operations, net of taxes

 

(0.2

)

(0.1

)

(0.1

)

(0.1

)

Net income

 

0.3

%

$

0.9

%

0.6

%

$

0.6

%

 

18



 

Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013

 

Net Sales

 

The following table presents our net sales by segment for the periods presented (in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

 

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net Sales

 

Percentage of
Total Net Sales

 

Net Sales

 

Percentage of
Total Net Sales

 

Dollar Change

 

Percent
Change

 

Commercial

 

$

256,385

 

75

%

$

257,374

 

73

%

$

(989

)

(0

)%

Public Sector

 

50,883

 

15

 

61,190

 

17

 

(10,307

)

(17

)

MacMall

 

32,363

 

10

 

36,934

 

10

 

(4,571

)

(12

)

Corporate & Other

 

(7

)

 

(1

)

 

(6

)

NM

(1)

Consolidated

 

$

339,624

 

100

%

$

355,497

 

100

%

$

(15,873

)

(4

)%

 


(1)  Not meaningful.

 

Consolidated net sales were $339.6 million in the three months ended June 30, 2014 compared to $355.5 million in the three months ended June 30, 2013, a decrease of $15.9 million, or 4%. Consolidated sales of services were $29.1 million in the three months ended June 30, 2014 compared to $32.5 million in the three months ended June 30, 2013, a decrease of $3.4 million, or 10%, and represented 9% of net sales in each of the three months ended June 30, 2014 and 2013, respectively.

 

Commercial net sales were $256.4 million in the three months ended June 30, 2014 compared to $257.4 million in the three months ended June 30, 2013, a decrease of $1.0 million. The decrease in Commercial net sales in the three months ended June 30, 2014 was primarily due to the non-recurrence of projects for certain large enterprise customers as compared to the same period in the prior year. Sales of services in the Commercial segment decreased by $3.5 million, or 11%, to $27.4 million in the three months ended June 30, 2014 from $30.9 million in the three months ended June 30, 2013, and represented 11% and 12% of Commercial net sales in the three months ended June 30, 2014 and 2013, respectively.

 

Public Sector net sales were $50.9 million in the three months ended June 30, 2014 compared to $61.2 million in the three months ended June 30, 2013, a decrease of $10.3 million, or 17%. This decrease in Public Sector net sales was due to a $11.5 million decrease in sales in our federal government business, primarily related to a reduction in sales made under our Social Security Administration and FBI contracts due to its unseasonably strong sales made during the three months ended June 30, 2013, which at the time grew 218% over the three months ended June 30, 2012, partially offset by an increase of $1.2 million in our state and local government and educational institutions business (SLED) resulting from increased account executive productivity in part related to the Common Core standards initiatives in the education sector.

 

MacMall net sales were $32.4 million in the three months ended June 30, 2014 compared to $36.9 million in the three months ended June 30, 2013, a decrease of $4.6 million, or 12%. The decrease in MacMall net sales was primarily due to a reduction in sales of MacBook Pro units, which were negatively impacted by pricing pressure from large online and retail competitors, partially offset by increases in Apple iMacs and MacBook Airs.

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $48.6 million in the three months ended June 30, 2014, a decrease of $1.4 million, or 3%, from $50.0 million in the three months ended June 30, 2013. Consolidated gross profit margin grew to 14.3% in the three months ended June 30, 2014 from 14.1% in the three months ended June 30, 2013. The decrease in gross profit was primarily related to the decreased sales. The increase in gross profit margin in the three months ended June 30, 2014 was primarily due to an improved solution sales mix, which contributed to an increase in vendor consideration, and increased agent fees associated with sales of enterprise software agreements.

 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses were $44.8 million in the three months ended June 30, 2014 compared to $43.4 million in the three months ended June 30, 2013, an increase of $1.4 million, or 3%.  Consolidated SG&A expenses as a percentage of net sales increased to 13.2% in the three months ended June 30, 2014 from 12.2% in the three months ended June 30, 2013. The increase in consolidated SG&A expenses in Q2 2014 was primarily due to a $0.4 million increase in personnel costs and a $0.3 million increase in professional services fees.

 

19



 

Operating Profit

 

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

 

 

 

Three Months Ended June 30,

 

 

 

 

 

Change in

 

 

 

2014

 

2013

 

 

 

Operating

 

 

 

Operating

 

Operating
Profit

 

Operating

 

Operating
Profit

 

Change in
Operating Profit

 

Profit
Margin

 

 

 

Profit

 

Margin(1)

 

Profit

 

Margin(1)

 

$

 

%

 

%

 

Commercial

 

$

14,215

 

5.5

%

$

16,989

 

6.6

%

$

(2,774

)

(16

)%

(1.1

)%

Public Sector

 

2,046

 

4.0

 

1,757

 

2.9

 

289

 

16

 

1.1

 

MacMall

 

274

 

0.8

 

1,032

 

2.8

 

(758

)

(73

)

(2.0

)

Corporate & Other

 

(12,654

)

(3.7

)(1)

(13,123

)

(3.7

)(1)

469

 

(4

)

0.0

 

Consolidated

 

$

3,881

 

1.1

%

$

6,655

 

1.9

%

$

(2,774

)

(42

)%

(0.8

)%

 


(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 was $3.9 million in the three months ended June 30, 2014 compared to $6.7 million in the three months ended June 30, 2013, a decrease of $2.8 million or 42%.

 

Commercial operating profit was $14.2 million in the three months ended June 30, 2014 compared to $17.0 million in the three months ended June 30, 2013, a decrease of $2.8 million, or 16%, primarily due to a $0.6 million decrease in Commercial gross profit and increased personnel costs of $1.6 million, which was primarily due to investments including software, technical solutions and sales personnel supporting our future growth initiatives, including our new office in Austin, Texas.

 

Public Sector operating profit was $2.0 million in the three months ended June 30, 2014 compared to $1.8 million in the three months ended June 30, 2013, an increase of $0.2 million, or 16%. This increase in Public Sector operating profit in the three months ended June 30, 2014 was primarily due to lower variable fulfillment costs.

 

MacMall operating profit was $0.3 million in the three months ended June 30, 2014 compared to $1.0 million in the three months ended June 30, 2013, a decrease of $0.7 million, or 73%, primarily due to a decrease in MacMall gross profit associated with the reduction in sales.

 

Corporate & Other operating expenses includes corporate related expenses such as legal, accounting, information technology, product management and certain other administrative costs that are not otherwise included in our reportable operating segments. Corporate & Other operating expenses were $12.7 million in the three months ended June 30, 2014 compared to $13.1 million in the three months ended June 30, 2013, a decrease of $0.4 million, or 4%, primarily due to reduced personnel costs of $0.9 million, partially offset by a $0.3 million increase in depreciation expense.

 

Net Interest Expense

 

Total net interest expense for each of the three months ended June 30, 2014 and 2013 was $0.8 million.

 

Income Tax Expense

 

We recorded an income tax expense of $1.3 million in the three months ended June 30, 2014 compared to an income tax expense of $2.5 million in the three months ended June 30, 2013. Our effective tax rate was 41% and 43% for the three months ended June 30, 2014 and 2013, respectively. The decrease in income tax expense was primarily due to a decrease in our pre-tax income. The decrease in our effective tax rate in the three months ended June 30, 2014 was primarily due to the revaluation of federal deferred tax assets and liabilities from 34% to 35% in the three months ended June 30, 2013, which was recorded as a discrete item, and the impact of higher permanent differences during 2013.

 

20



 

Loss from Discontinued Operations

 

Loss from discontinued operations, net of taxes, which represents the results of operations of the two closed retail stores and the OnSale and eCost businesses, was $0.7 million in the three months ended June 30, 2014 and $0.2 million in the three months ended June 30, 2013.

 

Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013

 

Net Sales

 

The following table presents our net sales by segment for the periods presented (in thousands):

 

 

 

Six Months Ended June 30,

 

 

 

 

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Net Sales

 

Percentage of
Total Net Sales

 

Net Sales

 

Percentage of
Total Net Sales

 

Dollar Change

 

Percent
Change

 

Commercial

 

$

508,506

 

76

%

$

508,741

 

75

%

$

(235

)

(0

)%

Public Sector

 

87,303

 

13

 

92,216

 

14

 

(4,913

)

(5

)

MacMall

 

74,547

 

11

 

77,216

 

11

 

(2,669

)

(3

)

Corporate & Other

 

(10

)

 

(66

)

 

56

 

NM

(1)

Consolidated

 

$

670,346

 

100

%

$

678,107

 

100

%

$

(7,761

)

(1

)%

 


(1)  Not meaningful.

 

Consolidated net sales were $670.3 million in the six months ended June 30, 2014 compared to $678.1 million in the six months ended June 30, 2013, a decrease of $7.8 million, or 1%. Consolidated sales of services were $58.1 million in the six months ended June 30, 2014 compared to $62.0 million in the six months ended June 30, 2013, a decrease of $3.9 million, or 6%, and represented 9% of net sales in each of the six months ended June 30, 2014 and 2013.

 

Commercial segment net sales were $508.5 million in the six months ended June 30, 2014 compared to $508.7 million in the six months ended June 30, 2013, a decrease of $0.2 million. The decrease in Commercial net sales in the six months ended June 30, 2014 was primarily due to the non-recurrence of projects for certain large enterprise customers as compared to the prior year. Sales of services in the Commercial segment decreased by $3.9 million, or 7%, to $55.3 million in the six months ended June 30, 2014 from $59.2 million in the six months ended June 30, 2013, and represented 11% and 12% of Commercial segment net sales in the six months ended June 30, 2014 and 2013 respectively.

 

Public Sector net sales were $87.3 million in the six months ended June 30, 2014 compared to $92.2 million in the six months ended June 30, 2013, a decrease of $4.9 million, or 5%. This decrease was primarily due to a decrease of $9.9 million, or 16%, in our federal government business, partially offset by an increase of $5.0 million, or 16%, in our SLED business. The decrease in our federal government business was primarily due to a reduction in sales made under certain of our new Federal contracts and continued Federal budgetary headwinds. The increase in our SLED business was primarily due to increased account executive productivity in part related to the Common Core standards initiatives in the education sector.

 

MacMall net sales were $74.5 million in the six months ended June 30, 2014 compared to $77.2 million in the six months ended June 30, 2013, a decrease of $2.7 million, or 3%. We believe MacMall net sales were negatively impacted by pricing pressure from large online and retail competitors.

 

Gross Profit and Gross Profit Margin

 

Consolidated gross profit was $98.2 million in the six months ended June 30, 2014, an increase of $2.8 million, or 3%, from $95.4 million in the six months ended June 30, 2013. Consolidated gross profit margin grew to 14.6% in the six months ended June 30, 2014 from 14.1% in the six months ended June 30, 2013. The increase in consolidated gross profit was primarily due to an increase in vendor consideration of $1.8 million. The increase in consolidated gross profit margin was primarily due to an improved solution sales mix, which contributed to an increase in vendor consideration, and increased agent fees associated with sales of enterprise software agreements.

 

21



 

Selling, General & Administrative Expenses

 

Consolidated SG&A expenses increased by $2.6 million, or 3%, to $88.2 million in the six months ended June 30, 2014 from $85.6 million in the six months ended June 30, 2013 primarily due to a $1.8 million increase in net personnel costs, a $0.4 million increase in professional fees, a $0.2 million increase in travel and entertainment expenses, and a $0.2 million increase in legal settlement costs, partially offset by reduction in bad debt expense of $0.5 million.

 

Operating Profit

 

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

 

 

 

Six Months Ended
June 30,

 

 

 

 

 

Change in

 

 

 

2014

 

2013

 

 

 

 

 

Operating

 

 

 

Operating

 

Operating
Profit

 

Operating

 

Operating
Profit

 

Change in
Operating Profit

 

Profit
Margin

 

 

 

Profit

 

Margin(1)

 

Profit

 

Margin(1)

 

$

 

%

 

%

 

Commercial

 

$

31,873

 

6.3

%

$

31,756

 

6.2

%

$

117

 

0

%

0.1

%

Public Sector

 

2,620

 

3.0

 

1,881

 

2.0

 

739

 

39

 

1.0

 

MacMall

 

1,076

 

1.4

 

1,755

 

2.3

 

(679

)

(39

)

(0.9

)

Corporate & Other

 

(25,580

)

(3.8

)(1)

(25,562

)

(3.8

)(1)

(18

)

0

 

0.0

 

Consolidated

 

$

9,989

 

1.5

%

$

9,830

 

1.4

%

$

159

 

2

%

0.1

%

 


(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 was $10.0 million in the six months ended June 30, 2014 compared to $9.8 million in the six months ended June 30, 2013, an increase of $0.2 million, or 2%.

 

Commercial operating profit was $31.9 million in the six months ended June 30, 2014 compared to $31.8 million in the six months ended June 30, 2013, an increase of $0.1 million, primarily due to the $3.1 million increase in Commercial gross profit, partially offset by a $2.9 million increase in personnel costs, which was primarily due to investments including software, technical solutions and sales personnel supporting our future growth initiatives, including our new office in Austin, Texas.

 

Public Sector operating profit was $2.6 million in the six months ended June 30, 2014 compared to $1.9 million in the six months ended June 30, 2013, an increase of $0.7 million or 39%, primarily due to a $0.6 million increase in Public Sector gross profit and $0.2 million decrease in variable fulfillment costs, partially offset by a $0.1 million increase in personnel costs.

 

MacMall operating profit was $1.1 million in the six months ended June 30, 2014 compared to $1.8 million in the six months ended June 30, 2013, a decrease of $0.7 million, primarily due to a $0.9 million decrease in MacMall gross profit associated with the reduction in sales and a $0.3 million legal settlement in the first quarter of 2014, partially offset by a $0.4 million decrease in personnel costs.

 

Corporate & Other operating expenses remained relatively flat at $25.6 million in each of the six months ended June 30, 2014 and 2013.

 

Net Interest Expense

 

Total net interest expense for the six months ended June 30, 2014 increased to $1.7 million compared with $1.6 million in the six months ended June 30, 2013. The $0.1 million increase in net interest expense was primarily due to higher average total outstanding borrowings during the six months ended June 30, 2014 compared to the same period in the prior year.

 

Income Tax Expense

 

We recorded an income tax expense of $3.4 million in the six months ended June 30, 2014 compared to an income tax expense of $3.5 million in the six months ended June 30, 2013. Our effective tax rate was 41% and 42% for the six months ended June 30, 2014 and 2013, respectively.

 

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Loss from Discontinued Operations

 

Loss from discontinued operations, net of taxes, was $0.8 million in the six months ended June 30, 2014 and $0.4 million in the six months ended June 30, 2013.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Working Capital. Our primary capital needs have been and are expected to continue to be the funding of our existing working capital requirements, capital expenditures for which we expect to include substantial investments in our new ERP system, eCommerce platform and other upgrades of our current IT infrastructure over the next several years, which are discussed further below in “Other Planned Capital Projects,” possible sales growth, possible acquisitions and new business ventures, including the execution of our rebranding strategy and possible repurchases of our common stock under a discretionary repurchase program, which is also further discussed below. 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 continuing efforts to drive revenue growth from commercial customers could result in an increase in our accounts receivable as these customers are generally provided longer payment terms than consumers. 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 capital investments, future strategic opportunities or growth beyond our current operating plans. We are also unable to quantify any expected future synergies or costs related to our ongoing rebranding and restructuring efforts.

 

There has been ongoing uncertainty in the global economic environment, which could cause disruptions in the capital and credit markets. While our revolving credit facility does not mature until September 2017, we believe 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 $6.7 million at June 30, 2014 and $10.0 million at December 31, 2013. Our working capital was $62.6 million as of June 30, 2014 and $57.6 million as of December 31, 2013.

 

In September 2012, our Board of Directors approved a $10 million increase to our discretionary stock repurchase program, which was originally adopted in October 2008 with an initial authorized maximum of $10 million. Under the program, shares may be repurchased from time to time at prevailing market prices, through open market or unsolicited negotiated transactions, depending on market conditions. We expect that the repurchase of our common stock under the program will be financed with existing working capital and amounts available under our existing credit facility. No limit was placed on the duration of the repurchase program. There is no guarantee as to the exact number of shares that we will repurchase. Subject to applicable securities laws, repurchases may be made at such times and in such amounts as our management deems appropriate. The program can also be discontinued at any time management feels additional purchases are not warranted. During the three months ended June 30, 2014, we repurchased a total of 42,866 shares of our common stock under this program for a total cost of approximately $0.4 million. From the inception of the program in October 2008 through June 30, 2014, we have repurchased an aggregate total of 2,888,581 shares of our common stock for a total cost of $14.7 million. The repurchased shares are held as treasury stock. At June 30, 2014, we had $5.3 million available in stock repurchases under the program, subject to any limitations that may apply from time to time under our existing credit facility.

 

We maintain a Canadian call center serving the U.S. market, which receives the benefit of labor credits under the Investment Quebec Refundable Tax Credit for Major Employment Generating Projects (GPCE) program. In addition to other eligibility requirements under the program, which extends through fiscal year 2016, we are required to maintain a minimum of 317 eligible employees employed by our subsidiary PCM Sales Canada in the province of Quebec at all times to remain eligible to apply annually for these labor credits. As a result of this 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, continuing through fiscal year 2016. As of June 30, 2014, we had a total accrued receivable of $8.6 million related to 2012, 2013 and the first half of 2014. Our 2012 claim has been processed and we are awaiting payment. We expect to file our 2013 claim in 2014 and we expect to receive full payment under our remaining accrued labor credits receivable. In June 2014, the province of Quebec passed a budget that modified the annual labor credit, prospectively reducing the claim percentage from 25% to 20% of eligible salaries, and reducing the annual amount from $15,000 to $12,000 (Canadian) per eligible employee per year.

 

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Cash Flows from Operating Activities. Net cash provided by operating activities was $61.6 million in the six months ended June 30, 2014 compared to $10.4 million of net cash used in operating activities in the six months ended June 30, 2013.

 

The $61.6 million of net cash provided by operating activities in the six months ended June 30, 2014 was primarily due to a decrease in inventory of $67.3 million due to the sell through of a majority of the inventory purchased for specific customer contracts and large strategic purchases made near the end of the year and a decrease in accounts receivable of $22.9 million, partially offset by a decrease in accounts payable of $37.6 million.

 

The $10.4 million of net cash used in operating activities in the six months ended June 30, 2013 was primarily due to a $27.3 million increase in accounts receivable due to increased sales, especially to certain federal government customers, partially offset by a $14.2 million increase in deferred revenue related to a deferred maintenance contract.

 

Cash Flows from Investing Activities. Net cash used in investing activities was $18.4 million in the six months ended June 30, 2014 compared to $7.4 million in the six months ended June 30, 2013.

 

The $18.4 million of net cash used in investing activities in the six months ended June 30, 2014 was primarily related to capital expenditures relating to our ERP upgrade, the construction of our new cloud data center in New Albany, Ohio, the expenditures relating to leasehold improvements and other build-out costs related to our new Chicago and Austin offices, and investments in our IT infrastructure and the creation of enhanced electronic tools for our account executives and sales support staff. The $7.4 million of net cash used in investing activities in the six months ended June 30, 2013 was primarily related to capital expenditures relating to investments in our IT infrastructure and the creation of enhanced electronic tools for our account executives and sales support staff. In addition, we incurred approximately $1.3 million of capital expenditures in the six months ended June 30, 2013 related to the unfinanced portion of a building we acquired that is adjacent to the building we own in Santa Monica, California.

 

Cash Flows from Financing Activities. Net cash used in financing activities in the six months ended June 30, 2014 was $46.5 million compared to net cash provided by financing activities of $23.0 million in the six months ended June 30, 2013.

 

The $46.5 million of net cash used in financing activities in the six months ended June 30, 2014 was primarily related to $57.8 million of net payments on the outstanding balance of our line of credit, partially offset by $9.1 million of borrowings under our notes payable related to the ERP upgrade and new cloud data center construction. The $23.0 million of net cash provided by financing activities in the six months ended June 30, 2013 was primarily related to a $12.8 million net increase in the outstanding balance of our line of credit and an $8.7 million change in book overdraft related to outstanding checks at June 30, 2013 compared to the prior year end.

 

Line of Credit and Note Payable. We maintain an asset-based revolving credit facility that provides for, among other things, (i) a credit limit of $200 million; (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 September 30, 2017. 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, and a portion of the value of certain real estate, 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.

 

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 1.0 to 1.0 calculated on a trailing four-quarter basis as of the end of the last quarter immediately preceding such FCCR triggering event date. At June 30, 2014, we were in compliance with our financial covenant under the credit facility.

 

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 our utilization of early-pay discounts. At June 30, 2014, we had $52.7 million of net working capital advances outstanding under the line of credit. At June 30, 2014, the maximum credit line was $200 million and we had $53.4 million available to borrow for working capital advances under the line of credit.

 

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In connection with, and as part of, our revolving credit facility, we maintain a term note with a principal balance of $4.34 million, payable in equal monthly principal installments, amortized over 84 months, beginning on April 1, 2013, plus interest at the prime rate with a LIBOR option. In the event of a default, termination or non-renewal of the revolving credit facility upon the maturity thereof, the term loan is payable in its entirety upon demand by the lenders. At June 30, 2014, we had $3.6 million outstanding under the term note. The remaining balance of our term note matures as follows: $0.3 million in the reminder of 2014, $0.6 million annually in each of the years 2015 through 2018, and $0.8 million thereafter.

 

In May 2013, we completed the purchase of real property adjacent to the building we own in Santa Monica, California for $3.0 million and financed $1.7 million of the purchase price with a sub-line under our revolving credit facility. The loan bears the same interest terms as our revolving credit facility. However, the principal amount is amortized monthly over an 84 month period similar to our term note, with monthly principal amortization of approximately $24,000 beginning in July 2014. Accordingly, at June 30, 2014, $0.3 million and $1.4 million were included in our “Notes Payable — current” and “Notes payable and other long-term liabilities” on our Condensed Consolidated Balance Sheets.

 

In June 2011, we entered into a credit agreement to finance the acquisition and improvement of the real property we purchased in March 2011 in El Segundo, California. The credit agreement provides for a five year term and a 25 year straight-line, monthly 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, payable monthly. At June 30, 2014, we had $9.1 million outstanding under this credit agreement, which matures as follows: $0.2 million in the remainder of 2014, $0.4 million in 2015 and $8.5 million in 2016. The loan is secured by the real property and contains financial covenants substantially similar to those of our existing asset-based credit facility.

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million, where we built a new cloud data center that we opened in late June 2014. The Tier III facility is strategically located in a data center-centric development in New Albany, Ohio. The new facility complements our two existing data centers and a 24/7 Integrated Operations Center (IOC) located in Atlanta, Georgia, enhancing our managed service offerings, including cloud services, data center hosting and management, remote monitoring and disaster recovery. In July 2013, we entered into a loan agreement for up to $7.725 million to finance the build out of the new data center. The loan agreement provides for draws during a construction period subsequent to reaching certain expenditure thresholds. Any outstanding borrowing during the construction period will bear interest at the prime rate plus 0.25%, followed by a five year term and a 25 year straight-line, monthly principal repayment amortization period with a balloon payment at maturity. Interest during the amortization period is variable, indexed to LIBOR plus a spread of 2.25%. At June 30, 2014, we had $4.3 million outstanding under this loan agreement.

 

At June 30, 2014, our effective weighted average annual interest rate on outstanding amounts under the credit facility, term note and notes payable was 2.1%.

 

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

 

ERP and Web Infrastructure Upgrades

 

We are currently upgrading many of our IT systems. We have purchased licenses for Microsoft Dynamics AX and other related ISV (Independent Software Vendor) modules (Tax, EDI, Freight, Pricing and Rebates) to provide a complete and robust solution.  We are currently working on the implementation of the ERP modules and the upgrade of the ERP systems, including additional enhancements and features. We believe the implementation and upgrade should help us to gain further efficiencies across our organization. While it is difficult to estimate costs and time frames for completion, based on the complexity of the systems design, customization and implementation and our current estimates, which are subject to change, we currently expect to incur a cost of approximately $24 million for the major phases of the ERP upgrade and to be complete with all major phases of the design, configuration and customization by the end of 2014. We expect to complete the implementation and migration of certain of the legacy systems to the new ERP solution by the end of 2015. To date, we have incurred approximately $21 million of such costs. In addition to the above expenditures, we expect to make periodic upgrades to our IT systems on an ongoing basis. In addition to the upgrades to our IT systems, we recently implemented various Cisco solutions to upgrade our communications infrastructure to provide a unified platform for our entire company and to provide a robust and efficient contact center.

 

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New Data Center

 

In December 2012, we completed the purchase of 7.9 acres of land for approximately $1.1 million and have incurred an additional cumulative $9.3 million through June 30, 2014 towards the construction of a new cloud data center that we opened in late June 2014. The Tier III facility is strategically located in a data center-centric development in New Albany, Ohio. The new facility complements our two existing data centers and a 24/7 Integrated Operations Center (IOC) located in Atlanta, Georgia, enhancing our managed service offerings, including cloud services, data center hosting and management, remote monitoring and disaster recovery. While the site is now fully operational, we expect a limited amount of capital expenditures to continue into the third quarter of 2014.

 

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.

 

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

 

Our off-balance sheet arrangements are fully described in our Annual Report on Form 10-K for the year ended December 31, 2013. As of June 30, 2014, there has been no material change in any off-balance sheet arrangements since December 31, 2013.

 

Contingencies

 

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

 

RELATED-PARTY TRANSACTIONS

 

There were no material related-party transactions during the three and six months ended June 30, 2014 other than compensation arrangements in the ordinary course of business.

 

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 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, investments in our planned new data center, our reorganization strategy, our brand strategy and initiatives to unify our commercial brands, our efforts to expand our sales of value-added services and solutions offerings, and real estate acquisitions and dispositions;

·                  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 systems and communications infrastructure upgrades;

·                  our expectations regarding key personnel and our ability to hire new and retain such individuals;

·                  our competitive advantages and growth opportunities;

·                  our ability to increase revenues and profitability;

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

·                  our plans to invest in and enhance programs and training to align us with our key vendor partners;

·                  our ability to generate vendor supported marketing;

 

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

·                  the expected results or profitability of any of our individual business units in future periods;

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

·                  our ability to penetrate the public sector market;

·                  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 and enhancement 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;

·                  our compliance with laws and regulations;

·                  our beliefs regarding the applicability of tax statutes, regulations and governmental tax regulatory positions;

·                  our expectations regarding the impact of accounting pronouncements;

·                  our expectations regarding any future repurchases of our common stock, including the financing of any such repurchases;

·                  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 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 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, accounts receivable, accounts payable, and short-term and long-term debt. At June 30, 2014, 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, 2014. 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, 2014, we had $52.7 million outstanding under our line of credit and $23.3 million outstanding under our notes payable. As of June 30, 2014, 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 $0.8 million.

 

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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 Condensed 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,” a separate component of stockholders’ equity on our Condensed Consolidated Balance Sheets. As such, we have foreign currency translation exposure for changes in exchange rates for these currencies. As of June 30, 2014, 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 Condensed Consolidated Statements of Operations and Condensed 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, 2014.

 

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 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not currently a party to any material legal proceedings, other than ordinary routine litigation incidental to the business. 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 be costly and 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 and communications systems.

 

We have committed significant resources to the development of sophisticated systems that are used to manage our business. Our 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 computers across all of our 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 and communications systems on a regular basis, which could require significant capital expenditures.

 

Our success is dependent on the accuracy and proper utilization of our management information systems and our communications systems. In addition to the costs associated with system upgrades, the transition to and implementation of new or upgraded solutions 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 currently contract with a third party service provider specializing in maintenance and support of this system to provide us adequate support until we finalize the upgrade of this system to Microsoft Dynamics AX. Any interruption, corruption, degradation or failure of our management information systems or communications systems could adversely impact our ability to receive and process customer orders on a timely basis.

 

In addition to our ERP and eCommerce systems upgrades that are currently being implemented, 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 these 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 system 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 such project delays, business interruptions or loss of expected benefits could have a material adverse effect on our business, financial condition or results of operations.

 

Any disruptions, delays or deficiencies in the design, operation or implementation of our various systems, or in the performance of our 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 or our ability to properly manage our inventory or accurately present our inventory availability or pricing. 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 or results of operations.

 

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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.

 

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, customers generally reduced, often substantially, their rate of information technology spending. Additionally, economic conditions and the level of consumer confidence has limited technology spending. 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 and prevent us from achieving our financial performance goals.

 

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 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, Cisco, Dell, HP, Lenovo and Microsoft. For example, products manufactured by HP represented approximately 19% and 21% of our net sales in the six months ended June 30, 2014 and 2013, respectively, and products manufactured by Apple represented approximately 17% of our net sales in each of the six months ended June 30, 2014 and 2013, respectively. 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.

 

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 Apple, Cisco, Dell, HP, Ingram Micro, Lenovo, Microsoft 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, divestitures, 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.

 

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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 HP and Apple products, they 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 on our websites and through our catalogs 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.

 

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

 

We are subject to intense price competition with respect to the products, services and solutions we sell. As a result, our gross margins have historically been narrow, and we expect them to continue to be narrow. We have recently experienced increasing price competition, which has a negative impact on our gross margins. Narrow gross margins magnify the impact of variations in operating costs and of adverse or unforeseen events on 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 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 or 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 relative mix of products, services and solutions sold during the period;

·                  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;

·                  variability in vendor programs;

 

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·                  the introduction of new products, services or solutions by us or 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 products, services or solutions we offer;

·                  consumer acceptance of new purchasing models;

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

·                  deferral of customer orders in anticipation of new offerings;

·                  product or solution enhancements or operating system changes;

·                  any inability on our part to obtain adequate quantities of products, services or solutions;

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

·                  our expenditures on new business ventures and acquisitions;

·                  performance of acquired businesses;

·                 adverse weather conditions that affect supply or customer 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.

 

Our focus on commercial 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 focus on commercial and public sector sales and related market share growth.  In competing in these markets, we face numerous risks and challenges, including competition from a wider range of sources and the need to continually develop and enhance strategic relationships. We cannot assure you that our focus on commercial 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 or 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, requirements that we provide representations, warranties and indemnities related to the products, services and solutions we sell, the potential lack of a limitation of our liability for damages from our product sales or 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. Similarly, many large commercial businesses also require us to regularly enter into complex contractual relationships involving various risks and uncertainties such as requirements that we provide representations, warranties and indemnities to our customers and potential lack of limitation of our liability for damages under some of such contracts.

 

Our strategy and investments in increasing the productivity of our account executives, and our focus on sales and delivery of technology services and solutions 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. Our customers are increasingly consuming IT in different and evolving ways and utilizing more elaborate services and solutions. In response, we are investing in our services and solutions capabilities and portfolio and are working with our customers to identify areas where they can gain efficiencies by outsourcing to us traditional IT functions. Specifically, we are focused on and investing in solutions around the data center (which includes storage and security solutions), cloud computing, collaboration, virtualization, secure mobility, borderless networks and enterprise software solutions. We cannot assure you that any of our investments in our outbound phone-based sales force or our focus on our services and solutions capabilities and portfolio will result in expanded market share or increased profitability in the near or long term.

 

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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 laws and regulations and related risks 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.

 

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, Washington or the District of Columbia) 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 related to companies that sell to the 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 with existing laws and regulations applicable to our business, many of these laws and regulations are unclear and have yet to be interpreted by courts, or may be subject to conflicting interpretations by courts. Further, no assurances can be given that new laws or regulations will not be enacted or adopted, or that our processes, programs and systems will be sufficient to comply with present or future laws or regulations, which might adversely affect our business, financial condition or results of operations.

 

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Such existing and future laws and regulations may also impede our business. Additionally, it is not always clear how existing laws and regulations governing issues such as property ownership, sales and other taxes, libel, trespass, data mining and collection, data security and personal privacy, among other laws, apply to our businesses. Unfavorable resolution of these issues may expose us to liability and costly changes in our business operations, and could reduce customer demand for our products, services and solutions.

 

Additionally, although historically only a small percentage of our total sales in any given quarter or year are made to customers outside of the continental United States, there is a possibility that a foreign jurisdiction may take the position that our business is subject to its laws and regulations, which could impose restrictions or burdens on us and expose us to tax and other potential liabilities and could also require costly changes to our business operations with respect to those jurisdictions. In some cases, our sales related to foreign jurisdictions could also be subject to export control laws and foreign corrupt practice laws and there is a risk that we could face allegations from U.S. or foreign governmental authorities alleging our failure to comply with the requirements of such laws subjecting us to costly litigation and potential significant governmental penalties or fines.

 

Part of our business strategy includes the opportunistic acquisition of other companies, and we may have difficulties integrating acquired companies into our operations in a cost-effective manner, if at all.

 

One element of our business strategy involves the potential expansion through opportunistic acquisitions of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, or add new business capabilities. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic partnerships, and the purchase or sale of assets. Our acquisition strategy depends on the availability of suitable acquisition candidates at reasonable prices and our ability to resolve challenges associated with integrating acquired businesses into our existing business. No assurance can be given that the benefits or synergies we may expect from the acquisition of companies or businesses will be realized to the extent or in the time frame we anticipate. We may lose key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans. In addition, acquisitions may involve a number of risks and difficulties, including expansion into new geographic markets and business areas, the diversion of management’s attention to the operations and personnel of the acquired company, the integration of the acquired company’s personnel, operations and management information (ERP) systems, changing relationships with customers, suppliers and strategic partners, and potential short-term adverse effects on our operating results. These challenges can be magnified as the size of the acquisition increases. Any delays or unexpected costs incurred in connection with the integration of acquired companies or otherwise related to the acquisitions could have a material adverse effect on our business, financial condition and results of operations.

 

Acquisitions may require large one-time charges and can result in increased debt or other contingent liabilities, adverse tax consequences, deferred compensation charges, the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, and the refinement or revision of fair value acquisition estimates following the completion of acquisitions, any of which items could negatively impact our business, financial condition and results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline.

 

An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, or involve our issuance of additional equity securities. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company. If we incur additional debt to pay for an acquisition, it may significantly reduce amounts that would otherwise be available under our credit facility, increase our interest expense, leverage and debt service requirements and could negatively impact our ability to comply with applicable financial covenants in our credit facility or limit our ability to obtain credit from our vendors. Acquired entities also may be highly leveraged or dilutive to our earnings per share, or may have unknown liabilities. In addition, the combined entity may have lower revenues or higher expenses and therefore may not achieve the anticipated results. Any of these factors relating to acquisitions could have a material adverse impact on our business, financial condition and results of operations.

 

We cannot assure you that we will be able to identify suitable acquisition opportunities, consummate any pending or future acquisitions or that we will realize any anticipated benefits from any such acquisitions. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions on commercially acceptable terms, and any decline in the price of our common stock may make it significantly more difficult and expensive to initiate or consummate additional acquisitions. We cannot assure you that we will be able to implement or sustain our acquisition strategy or that our strategy will ultimately prove profitable.

 

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If goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.

 

The purchase price allocation for our historical acquisitions resulted in a material amount allocated to goodwill and intangible assets. In accordance with GAAP, we review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We review the fair values of our goodwill and intangible assets with indefinite useful lives and test them for impairment annually or whenever events or changes in circumstances indicate an impairment may have occurred. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or intangible assets may not be recoverable include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant non-cash charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill or intangible assets is determined, which could have a material adverse effect on our results of operations.

 

If significant negative industry or economic trends, including decreases in our market capitalization, slower growth rates or lack of growth in our business occurs in the future it may indicate that impairment charges are required. If we are required to record any impairment charges, this could have a material adverse effect on our consolidated financial statements. In addition, the testing of goodwill for impairment requires us to make significant estimates about the future performance and cash flows of our company, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in underlying business operations, future reporting unit operating performance, existing or new product market acceptance, changes in competition, or changes in technologies. Any changes in key assumptions, or actual performance compared with those assumptions, about our business and future prospects or other assumptions could affect the fair value of one or more reporting units, resulting in an impairment charge.

 

We may not be able to maintain profitability on a quarterly or annual basis.

 

Our ability to maintain profitability on a quarterly or annual basis given our planned business strategy depends upon a number of factors, including but not limited to our ability to achieve and maintain vendor relationships, procure merchandise and fulfill orders in an efficient manner, leverage our fixed cost structure, maintain adequate levels of vendor consideration and price protection, maintain a well-balanced product and customer mix, maintain customer acquisition costs and shipping costs at acceptable levels, and our ability to effectively compete in the marketplace with our competitors. Our ability to maintain profitability on a quarterly or annual basis will also depend on our ability to manage and control operating expenses and to generate and sustain adequate levels of revenue. Many of our expenses are fixed in the short term, and we may not be able to quickly reduce spending if our revenue is lower than what we project. In addition, we may find that our business plan costs more to execute than what we currently anticipate. Some of the factors that affect our ability to maintain profitability on a quarterly or annual basis are beyond our control, including general economic trends and uncertainties.

 

The effect of accounting rules for stock-based compensation may materially adversely affect our consolidated operating results, our stock price and our ability to hire, retain and motivate employees.

 

We use employee stock options and other stock-based compensation to hire, retain and motivate certain of our employees. Current accounting rules require us to measure compensation costs for all stock-based compensation (including stock options) at fair value as of the date of grant and to recognize these costs as expenses in our consolidated statements of operations. The recognition of non-cash stock-based compensation expenses in our consolidated statements of operations has had and will likely continue to have a negative effect on our consolidated operating results, including our net income and earnings per share, which could negatively impact our stock price. Additionally, if we reduce or alter our use of stock-based compensation to reduce these expenses and their impact, our ability to hire, motivate and retain certain employees could be adversely affected and we may need to increase the cash compensation we pay to these employees.

 

Our operating results are difficult to predict and may adversely affect our stock price.

 

Our operating results have fluctuated in the past and are likely to vary significantly in the future based upon a number of factors, many of which we cannot control. We operate in a highly dynamic industry and future results could be subject to significant fluctuations. These fluctuations could cause us to fail to meet or exceed financial expectations of investors or analysts, which could cause our stock price to decline rapidly and significantly. Revenue and expenses in future periods may be greater or less than revenue and expenses in the immediately preceding period or in the comparable period of the prior year. Therefore, period-to-period comparisons of our operating results are not necessarily a good indication of our future performance. Some of the factors that could cause our operating results to fluctuate include:

 

·             changes in the mix of products, services or solutions that we sell;

·             the amount and timing of operating costs and capital expenditures relating to any expansion of our business operations and infrastructure;

·             price competition that results in lower sales volumes, lower profit margins, or net losses;

·             the availability of vendor programs, authorizations or certifications;

·             our ability to attract and retain key personnel and the related costs,

 

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·             fluctuations in the demand for our products, services or solutions or overstocking or under-stocking of our products;

·             economic conditions;

·             changes in the amounts of information technology spending by our customers;

·             the amount and timing of advertising and marketing costs;

·             fluctuations in levels of inventory theft, damage or obsolescence that we incur;

·             our ability to successfully integrate operations and technologies from any past or future acquisitions or other business combinations;

·             revisions or refinements of fair value estimates relating to acquisitions or other business combinations;

·             changes in the number of visitors to our websites or our inability to convert those visitors into customers;

·             technical difficulties, including system or Internet failures;

·             introduction of new or enhanced products, services or solutions by us or our competitors;

·             fluctuations in our shipping costs; and

·             foreign currency exchange rates.

 

If we fail to accurately predict our inventory risk, our gross margins may decline as a result of required inventory write downs due to lower prices obtained from older or obsolete products.

 

We derive a significant amount of our gross sales from products sold out of inventory at our distribution facilities. We assume the inventory damage, theft and obsolescence risks, as well as price erosion risks for products that are sold out of inventory stocked at our distribution facilities. These risks are especially significant because many of the products we sell are characterized by rapid technological change, obsolescence and price erosion, and because our distribution facilities sometimes stock large quantities of particular types of inventory. There can be no assurance that we will be able to identify and offer products necessary to remain competitive, maintain our gross margins, or avoid or minimize losses related to excess and obsolete inventory. We currently have limited return rights with respect to products we purchase from Apple, HP and certain other vendors, but these rights vary by product line, are subject to specified conditions and limitations, and can be terminated or changed at any time.

 

We may need additional financing and may not be able to raise additional financing on favorable terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership interests of existing stockholders.

 

We require substantial working capital to fund our business. 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 existing credit facility, which functions as a working capital line of credit, will be adequate to support our current operating plans for at least the next twelve months. However, if we need additional financing, such as for acquisitions or expansion of our business or the businesses of our subsidiaries or to finance our operations during a significant downturn in sales or an increase in operating expenses, there are no assurances that adequate financing will be available on acceptable terms, if at all. We may in the future seek additional financing from public or private debt or equity financings to fund additional expansion, or take advantage of strategic opportunities or favorable market conditions. There can be no assurance such financings will be available on terms favorable to us or at all. To the extent any such financings involve the issuance of equity securities, existing stockholders could suffer dilution. If we raise additional financing through the issuance of equity, equity-related or debt securities, those securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders will experience dilution of their ownership interests. If additional financing is required but not available, we would have to implement further measures to conserve cash and reduce costs. However, there is no assurance that such measures would be successful. Our failure to raise required additional financing could adversely affect our ability to maintain, develop or enhance our product offerings, take advantage of future strategic opportunities, respond to competitive pressures or continue operations.

 

Economic volatility and geopolitical uncertainty could result in disruptions of the capital and credit markets. 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 changes in our sales or an increase in our operating expenses, or to take advantage of strategic opportunities or favorable market conditions. 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.

 

Rising interest rates could negatively impact our results of operations and financial condition.

 

A significant portion of our working capital requirements and our real estate acquisitions have historically been funded through borrowings under our working capital credit facility or through long term notes.  These facilities bear interest at variable rates tied to the LIBOR or prime rate, and the long term notes generally have initial terms of between five and seven years. If the variable interest rates on our borrowings increase, we could incur greater interest expense than we have in the past. Rising interest rates, and our increased interest expense that would result from them, could negatively impact our results of operations and financial condition.

 

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We may be subject to claims regarding our intellectual property, including our business processes, or the products, services or solutions we sell, any of which could result in expensive litigation, distract our management or force us to enter into costly royalty or licensing agreements.

 

Third parties have asserted, and may in the future assert, that our business or the technologies we use or sell infringe on their intellectual property rights. As a result, we may be subject to intellectual property legal proceedings and claims in the ordinary course of our business. We cannot predict whether third parties will assert additional claims of infringement against us in the future or whether any future claims will prevent us from offering popular products or operating our business as planned. If we are forced to defend against any third-party infringement claims, whether they are with or without merit or are determined in our favor, we could face expensive and time-consuming litigation, which could result in the imposition of a preliminary injunction preventing us from continuing to operate our business as currently conducted throughout the duration of the litigation or distract our technical and management personnel. If we are found to infringe, we may be required to pay monetary damages, which could include treble damages and attorneys’ fees for any infringement that is found to be willful, and either be enjoined or required to pay ongoing royalties with respect to any technologies found to infringe. Further, as a result of infringement claims either against us or against those who license technology to us, we may be required, or deem it advisable, to develop non-infringing technology, which could be costly and time consuming, or enter into costly royalty or licensing agreements. Such royalty or licensing agreements, if required, may be unavailable on terms that are acceptable to us, or at all. If a third party successfully asserts an infringement claim against us and we are enjoined or required to pay monetary damages or royalties or we are unable to develop suitable non-infringing alternatives or license the infringed or similar technology on reasonable terms on a timely basis, our business, results of operations and financial condition could be materially harmed. Similarly, we may be required incur substantial monetary and diverted resource costs in order to protect our intellectual property rights against infringement by others.

 

Furthermore, we sell products and solutions manufactured and distributed by third parties, some of which may be defective. If any product or solution that we sell were to cause physical injury or damage to property, the injured party or parties could bring claims against us as the retailer of the product or solution. Our insurance coverage may not be adequate to cover every claim that could be asserted. If a successful claim were brought against us in excess of our insurance coverage, it could expose us to significant liability. Even unsuccessful claims could result in the expenditure of funds and management time and could decrease our profitability.

 

Costs and other factors associated with pending or future litigation could materially harm our business, results of operations and financial condition.

 

From time to time we receive claims and become subject to litigation, including consumer protection, employment, intellectual property and other litigation related to the conduct of our business. Additionally, we may from time to time institute legal proceedings against third parties to protect our interests. Any litigation that we become a party to could be costly and 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 and could incur significant costs in asserting, defending, or settling any such litigation. We cannot determine with any certainty the costs or outcome of pending or future litigation. Any such litigation may materially harm our business, results of operations or financial condition.

 

We may fail to expand our product, services and solutions categories and offerings or our websites or our processing systems in a cost-effective and timely manner as may be required to efficiently operate our business.

 

We may be required to expand or change our product, services and solutions categories or offerings, our websites or our processing systems in order to compete in our highly competitive and rapidly changing industry or to efficiently operate our business. Any failure on our part to expand or change the way we do business in a cost-effective and timely manner in response to any such requirements would likely adversely affect our operating results, financial condition or future prospects. Additionally, we cannot assure you that we will be successful in implementing any such changes when and if they are required.

 

We have generated substantial portions of our revenue in the past from the sale of computer hardware, software and accessories and consumer electronics products. Expansion into new product, service and solutions categories, including for example our efforts to grow our value-added services and solutions, may require us to incur significant marketing expenses, develop relationships with new vendors and comply with new regulations. We may lack the necessary expertise in a new category to realize the expected benefits of that new category. These requirements could strain our managerial, financial and operational resources. Additional challenges that may affect our ability to expand into new product, service or solutions categories include our ability to:

 

·             establish or increase awareness of our new brands and product, service and solutions categories;

 

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·             acquire, attract and retain customers at a reasonable cost;

·             achieve and maintain a critical mass of customers and orders across all of our product categories;

·             attract a sufficient number of new customers to whom any new categories and offerings are targeted;

·             successfully market our new categories or offerings to existing customers;

·             maintain or improve our gross margins and fulfillment costs;

·             attract and retain vendors to provide expanded lines of products, services or solutions to our customers on terms that are acceptable to us; and

·             manage our inventory in new product categories.

 

We cannot be certain that we will be able to successfully address any or all of these challenges in a manner that will enable us to expand our business into new categories in a cost-effective or timely manner. If our new categories are not received favorably, or if our suppliers fail to meet our customers’ expectations, our results of operations would suffer and our reputation and the value of the applicable new brand and our other brands could be damaged. The lack of market acceptance of our new categories or our inability to generate satisfactory revenue from any such expanded offerings to offset their cost could harm our business, financial condition or results of operations.

 

We may not be able to attract and retain key personnel such as senior management, sales, services and solutions personnel or information technology specialists.

 

Our future performance will depend to a significant extent upon the efforts and abilities of certain key management and other personnel, including Frank F. Khulusi, our Chairman of the Board and Chief Executive Officer, as well as other executive officers and senior management. The loss of service of one or more of our key management members could have a material adverse effect on our business. Our success and plans for future growth will also depend in part on our management’s continuing ability to hire, train and retain skilled personnel in all areas of our business such as sales, service and solutions personnel and IT personnel. For example, our management information systems and processes require the services of employees with extensive knowledge of these systems and processes and the business environment in which we operate, and in order to successfully implement and operate our systems and processes we must be able to attract and retain a significant number of information technology specialists. We may not be able to attract, train and retain the skilled personnel required to, among other things, implement, maintain, and operate our information systems and processes, and any failure to do so would likely have a material adverse effect on our operations.

 

If we fail to achieve and maintain adequate internal controls, we may not be able to produce reliable financial reports in a timely manner or prevent financial fraud.

 

We monitor and periodically test our internal control procedures. We may from time to time identify deficiencies which we may not be able to remediate in a timely or cost-effective manner. In addition, if we fail to achieve and maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting. Effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important in helping prevent financial fraud. If we cannot provide reliable financial reports on a timely basis or prevent financial fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information, and the trading price of our stock could drop significantly.

 

Any inability to effectively manage our growth may prevent us from successfully expanding our business.

 

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