| PC CONNECTION INC Item 1A Risk Factors Statements contained or incorporated by reference in this Annual Report on Form 10-K that are not based on historical fact are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act |
| These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management including, without limitation, our expectations with regard to the industry’s rapid technological change and exposure to inventory obsolescence, availability and allocations of goods, reliance on vendor support and relationships, competitive risks, pricing risks, and the overall level of economic activity and the level of business investment in information technology products |
| Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “could,” “will,” “expect,” “estimate,” “anticipate,” “continue,” or similar terms, variations of such terms or the negative of those terms |
| We cannot assure investors that our assumptions and expectations will prove to have been correct |
| Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements |
| Such factors that could cause or contribute to such differences include those factors discussed below |
| We undertake no intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise |
| If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer |
| FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION We have experienced variability in sales, and there is no assurance that we will be able to maintain profitable operations |
| Several factors have caused our sales and results of operations to fluctuate and we expect these fluctuations to continue on a quarterly basis |
| Causes of these fluctuations include: • changes in the overall level of economic activity; • the condition of the personal computer industry in general; • changes in the level of business investment in information technology products; • shifts in customer demand for hardware and software products; • variations in levels of competition; • industry shipments of new products or upgrades; • the timing of new merchandise and catalog offerings; • fluctuations in response rates; • fluctuations in postage, paper, shipping, and printing costs and in merchandise returns; • adverse weather conditions that affect response, distribution, or shipping; • changes in our product offerings; • changes in consumer demand for information technology products; and • changes in vendor distribution of products |
| Our results also may vary based on our success of integrating acquisitions into our business, the impact of the costs of acquisitions and integration, and our ability to hire and retain sales representatives and other essential personnel |
| In addition, customer response rates for our catalogs and other marketing vehicles are subject to variations |
| The first and last quarters of the year generally have higher response rates while the two middle quarters typically have lower response rates |
| 10 ______________________________________________________________________ [34]Table of Contents We base our operating expenditures on sales forecasts |
| If our revenues do not meet anticipated levels in the future, we may not be able to reduce our staffing levels and operating expenses in a timely manner to avoid significant losses from operations |
| Despite our August 2004 award of an authorization to sell to the federal government under a new General Services Administration (“GSA”) schedule, our sales to that organization may not regain prior years’ sales levels, which would negatively impact our business |
| In November 2003, we were advised that the GSA canceled its contract with our subsidiary, GovConnection, following a review of its contract management system and procedures and the possibility of the sale of unqualified items or underpayment of required fees |
| The matter has been referred to the Department of Justice for review, and we are cooperating in that review |
| While we were awarded authorization in August 2004 to resume selling to the federal government under a new GSA schedule, we experienced significant declines in our 2004 and 2005 federal government sales from 2003 levels |
| Accordingly, our revenues may continue to be adversely impacted as we attempt to regain this business |
| We are exposed to inventory obsolescence due to the rapid technological changes occurring in the personal computer industry |
| The market for personal computer products is characterized by rapid technological change and the frequent introduction of new products and product enhancements |
| Our success depends in large part on our ability to identify and market products that meet the needs of customers in that marketplace |
| In order to satisfy customer demand and to obtain favorable purchasing discounts, we have and may continue to carry increased inventory levels of certain products |
| By so doing, we are subject to the increased risk of inventory obsolescence |
| Also, in order to implement our business strategy, we intend to continue, among other things, placing larger than typical inventory stocking orders and increasing our participation in first-to-market purchase opportunities |
| We may also participate in end-of-life-cycle purchase opportunities and market products on a private-label basis, which would increase the risk of inventory obsolescence |
| In addition, we sometimes acquire special purchase products without return privileges |
| There can be no assurance that we will be able to avoid losses related to obsolete inventory |
| In addition, manufacturers are limiting return rights and are taking steps to reduce their inventory exposure by supporting “build-to-order” programs authorizing distributors and resellers to assemble computer hardware under the manufacturers’ brands |
| These trends reduce the costs to manufacturers and shift the burden of inventory risk to resellers like us, which could negatively impact our business |
| We acquire products for resale from a limited number of vendors |
| The loss of any one of these vendors could have a material adverse effect on our business |
| We acquire products for resale both directly from manufacturers and indirectly through distributors and other sources |
| The five vendors supplying the greatest amount of goods to us constituted 67prca, 63prca, and 63prca of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively |
| Among these five vendors, purchases from Ingram represented 26prca, 27prca, and 22prca of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively |
| Purchases from Tech Data comprised 19prca, 14prca, and 15prca of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively |
| Purchases from HP represented 11prca, 11prca, and 15prca of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively |
| No other vendor supplied more than 10prca of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively |
| If we were unable to acquire products from Ingram, HP, or Tech Data, we could experience a short-term disruption in the availability of products, and such disruption could have a material adverse effect on our results of operations and cash flows |
| Substantially all of our contracts and arrangements with our vendors that supply significant quantities of products are terminable by such vendors or us without notice or upon short notice |
| Most of our product vendors provide us with trade credit, of which the net amount outstanding at December 31, 2005 was dlra114dtta4 million |
| 11 ______________________________________________________________________ [35]Table of Contents Termination, interruption, or contraction of relationships with our vendors, including a reduction in the level of trade credit provided to us, could have a material adverse effect on our financial position |
| Some product manufacturers either do not permit us to sell the full line of their products or limit the number of product units available to direct marketers such as us |
| An element of our business strategy is to continue increasing our participation in first-to-market purchase opportunities |
| The availability of certain desired products, especially in the direct marketing channel, has been constrained in the past |
| We could experience a material adverse effect to our business if we are unable to source first-to-market purchase or similar opportunities, or if we face the reemergence of significant availability constraints |
| We may experience a reduction in the incentive programs offered to us by our vendors |
| Some product manufacturers and distributors provide us with incentives such as supplier reimbursements, payment discounts, price protection, rebates, and other similar arrangements |
| The increasingly competitive computer hardware market has already resulted in the following: • reduction or elimination of some of these incentive programs; • more restrictive price protection and other terms; and • reduced advertising allowances and incentives, in some cases |
| This support significantly defrays our catalog production expense |
| In the past, we have experienced a decrease in the level of co-op advertising support available to us from certain manufacturers |
| The level of co-op advertising support we receive from some manufacturers may further decline in the future |
| Such a decline could decrease our gross margin and increase our SG&A expenses as a percentage of sales and have a material adverse effect on our cash flows |
| We face many competitive risks |
| The direct marketing industry and the computer products retail business, in particular, are highly competitive |
| We compete with consumer electronics and computer retail stores, including superstores |
| We also compete with other direct marketers of hardware and software and computer related products, including CDW Corporation, Insight Enterprises, Inc, and Dell Inc, who are much larger than we are |
| Certain hardware and software vendors, such as HP, Lenovo, and Apple, who provide products to us, are also selling their products directly to end users through their own catalogs and over the Internet |
| We compete not only for customers, but also for co-op advertising support from personal computer product manufacturers |
| Some of our competitors have larger catalog circulations and customer bases and greater financial, marketing, and other resources than we do |
| In addition, some of our competitors offer a wider range of products and services than we do and may be able to respond more quickly to new or changing opportunities, technologies, and customer requirements |
| Many current and potential competitors also have greater name recognition, engage in more extensive promotional activities, and adopt pricing policies that are more aggressive than ours |
| We expect competition to increase as retailers and direct marketers who have not traditionally sold computers and related products enter the industry |
| In addition, product resellers and direct marketers are combining operations or acquiring or merging with other resellers and direct marketers to increase efficiency |
| Moreover, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to enhance their products and services |
| Accordingly, it is possible that new competitors or alliances among competitors may emerge and acquire significant market share |
| We cannot assure you that we can continue to compete effectively against our current or future competitors |
| If we encounter new competition or fail to compete effectively against our competitors, our business may be harmed |
| 12 ______________________________________________________________________ [36]Table of Contents We face and will continue to face significant price competition |
| Generally, pricing is very aggressive in the personal computer industry, and we expect pricing pressures to continue |
| An increase in price competition could result in a reduction of our profit margins |
| There can be no assurance that we will be able to offset the effects of price reductions with an increase in the number of customers, higher sales, cost reductions, or otherwise |
| Also, our sales of personal computer hardware products are generally producing lower profit margins than those associated with software products |
| Such pricing pressures could result in an erosion of our market share, reduced sales, and reduced operating margins, any of which could have a material adverse effect on our business |
| The methods of distributing personal computers and related products are changing, and such changes may negatively impact us and our business |
| The manner in which personal computers and related products are distributed and sold is changing, and new methods of distribution and sale, such as online shopping services, have emerged |
| Hardware and software manufacturers have sold, and may intensify their efforts to sell, their products directly to end users |
| From time to time, certain manufacturers have instituted programs for the direct sales of large order quantities of hardware and software to certain major corporate accounts |
| These types of programs may continue to be developed and used by various manufacturers |
| Some of our vendors, including Apple, HP, and Lenovo, currently sell some of their products directly to end users and have stated their intentions to increase the level of such direct sales |
| In addition, manufacturers may attempt to increase the volume of software products distributed electronically to end users |
| An increase in the volume of products sold through or used by consumers of any of these competitive programs or distributed electronically to end users could have a material adverse effect on our results of operations |
| We could experience system failures which would interfere with our ability to process orders |
| We depend on the accuracy and proper use of our management information systems, including our telephone system |
| Many of our key functions depend on the quality and effective utilization of the information generated by our management information systems, including: • our ability to manage inventory and accounts receivable collection; • our ability to purchase, sell, and ship products efficiently and on a timely basis; and • our ability to maintain operations |
| Our management information systems require continual upgrades to most effectively manage our operations and customer database |
| We are currently in the midst of a major upgrade to our sales processing system |
| Although we maintain some redundant systems, with full data backup, a substantial interruption in management information systems or in telephone communication systems, including those resulting from natural disasters as well as power loss, telecommunications failure, and similar events, would substantially hinder our ability to process customer orders and thus could have a material adverse effect on our business |
| We rely on the continued development of electronic commerce and Internet infrastructure development |
| We have had an increasing level of sales made over the Internet in part because of the growing use and acceptance of the Internet by end users |
| No one can be certain that acceptance and use of the Internet will continue to develop or that a sufficiently broad base of consumers will adopt and continue to use the Internet and other online services as a medium of commerce |
| Sales of computer products over the Internet represent a significant and increasing portion of overall computer product sales |
| Growth of our Internet sales is dependent on potential customers using the Internet in addition to traditional means of commerce to purchase products |
| We cannot accurately predict the rate at which they will do so |
| Our success in growing our Internet business will depend in large part upon the development of an infrastructure for providing Internet access and services |
| If the number of Internet users or their use of Internet 13 ______________________________________________________________________ [37]Table of Contents resources continues to grow rapidly, such growth may overwhelm the existing Internet infrastructure |
| Our ability to increase the speed with which we provide services to customers and to increase the scope of such services ultimately is limited by, and reliant upon, the speed, reliability, and cost-effectiveness of the networks operated by third parties, and these networks may not continue to be developed or be available at prices consistent with our required business model |
| We ship approximately 50prca of our products to customers by DHL Worldwide Express (“DHL”), with the remainder being shipped by United Parcel Service, Inc |
| and other overnight delivery and surface services |
| A strike or other interruption in service by these shippers could adversely affect our ability to market or deliver products to customers on a timely basis |
| We may experience potential increases in shipping, paper, and postage costs, which may adversely affect our business if we are not able to pass such increases on to our customers |
| Shipping costs are a significant expense in the operation of our business |
| Increases in postal or shipping rates and paper costs could significantly impact the cost of producing and mailing our catalogs and shipping customer orders |
| Postage prices and shipping rates increase periodically, and we have no control over future increases |
| We have a long-term contract with DHL whereby DHL ships products to our customers |
| We believe that we have negotiated favorable shipping rates with DHL We generally invoice customers for shipping and handling charges |
| There can be no assurance that we will be able to pass on to our customers the full cost, including any future increases in the cost, of commercial delivery services such as DHL We also incur substantial paper and postage costs related to our marketing activities, including producing and mailing our catalogs |
| Paper prices historically have been cyclical, and we have experienced substantial increases in the past |
| Significant increases in postal or shipping rates and paper costs could adversely impact our business, financial condition, and results of operations, particularly if we cannot pass on such increases to our customers or offset such increases by reducing other costs |
| Privacy concerns with respect to list development and maintenance may materially adversely affect our business |
| We mail catalogs and send electronic messages to names in our proprietary customer database and to potential customers whose names we obtain from rented or exchanged mailing lists |
| World-wide public concern regarding personal privacy has subjected the rental and use of customer mailing lists and other customer information to increased scrutiny |
| Any domestic or foreign legislation enacted limiting or prohibiting these practices could negatively affect our business |
| We face many uncertainties relating to the collection of state sales and use tax |
| We presently collect sales and use tax on sales of products to residents in many states |
| During the year ended December 31, 2005, we collected sales and use tax on approximately 19prca of our net sales |
| Various states have sought to impose on direct marketers the burden of collecting state sales and use taxes on the sales of products shipped to their residents |
| In 1992, the United States Supreme Court affirmed its position that it is unconstitutional for a state to impose sales or use tax collection obligations on an out-of-state mail-order company whose only contacts with the state are limited to the distribution of catalogs and other advertising materials through the mail and the subsequent delivery of purchased goods by United States mail or by interstate common carrier |
| However, legislation that would expand the ability of states to impose sales and use tax collection obligations on direct marketers has been introduced in Congress on many occasions |
| Additionally, certain states have adopted rules that require companies and their affiliates to register in those states as a condition of doing business within those states |
| Moreover, due to our presence on various forms of electronic 14 ______________________________________________________________________ [38]Table of Contents media and other operational factors, our contacts with many states may exceed the limited contacts involved in the Supreme Court case |
| We cannot predict the level of contacts that is sufficient to permit a state to impose on us a sales or use tax collection obligation |
| Two of our competitors have elected to collect sales and use taxes in all states |
| If the Supreme Court changes its position, or if legislation is passed to overturn the Supreme Court’s decision, or if a court were to determine that our contacts with a state exceed the constitutionality permitted contacts, the imposition of a sales or use tax collection obligation on us in states to which we ship products would result in additional administrative expenses to us, could result in tax liability for past sales as well as price increases to our customers, and could reduce demand for our product |
| We are dependent on key personnel |
| Our future performance will depend to a significant extent upon the efforts and abilities of our senior executives |
| The competition for qualified management personnel in the computer products industry is very intense, and the loss of service of one or more of these persons could have an adverse effect on our business |
| Our success and plans for future growth will also depend on our ability to hire, train, and retain skilled personnel in all areas of our business, including sales account managers and technical support personnel |
| There can be no assurance that we will be able to attract, train, and retain sufficient qualified personnel to achieve our business objectives |
| We are controlled by two principal stockholders |
| Patricia Gallup and David Hall, our two principal stockholders, beneficially own or control, in the aggregate, approximately 68prca of the outstanding shares of our common stock |
| Because of their beneficial stock ownership, these stockholders can continue to elect the members of the Board of Directors and decide all matters requiring stockholder approval at a meeting or by a written consent in lieu of a meeting |
| Similarly, such stockholders can control decisions to adopt, amend, or repeal our charter and our bylaws, or take other actions requiring the vote or consent of our stockholders and prevent a takeover of us by one or more third parties, or sell or otherwise transfer their stock to a third party, which could deprive our stockholders of a control premium that might otherwise be realized by them in connection with an acquisition of us |
| Such control may result in decisions that are not in the best interest of our public stockholders |
| In connection with our initial public offering, the principal stockholders placed substantially all shares of common stock beneficially owned by them into a voting trust, pursuant to which they are required to agree as to the manner of voting such shares in order for the shares to be voted |
| Such provisions could discourage bids for our common stock at a premium as well as have a negative impact on the market price of our common stock |