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PC MALL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following Management's Discussion and Analysis of Financial
Condition and Results of Operations together with the consolidated financial
statements and related notes thereto included elsewhere in this report. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of various factors, including
those described under "Risk Factors" in Item 1A and elsewhere in this report.
BUSINESS OVERVIEW
PC Mall, Inc. is a leading technology solutions provider to businesses,
government and educational institutions and individual consumers. We go to
market through our dedicated sales force of over 700 account executives. We also
offer our products, services and solutions through our field service teams,
various direct marketing techniques and a limited number of retail stores. Since
our founding in 1987, we have served our customers in part by offering them
multi-branded hardware solutions from leading brands including HP, Apple, Cisco,
Microsoft and Lenovo. Through us, these and other manufacturers are able to
reach multiple customer segments including consumers, small and medium sized
businesses, large enterprise businesses, as well as state, local and federal
governments and educational institutions. We add additional value to our
manufacturer partners by being able to sell, deliver and incorporate their
products and services into comprehensive solutions with a high degree of
customization. Our model also facilitates an efficient supply chain and support
mechanism for manufacturers by using a combination of direct marketing,
centralized selling and support, and centralized product fulfillment.
In conjunction with our eCost.com acquisition, which is discussed in detail
below, beginning with the first quarter of 2011, our management considered the
OnSale and eCOST businesses together as a separate segment and reported their
results accordingly. As such, in 2011, existing sales under the OnSale brand
were no longer reported under the MacMall segment and we had five operating
segments: SMB, MME, Public Sector, MacMall and OnSale.
In the first quarter of 2012, we determined that certain product sales in a
daily deal format marketed under our OnSale segment's daily deal business can do
considerably better than in a traditional ecommerce catalog format. As this
"daily deal" market and its related customer buying behaviors have continued to
evolve, the "daily deals" business model is rapidly expanding to include sales
of IT products. In response to these developments, we determined that our
strategic objectives can be best achieved by incorporating the best practices,
technologies and methodologies we have developed in our stand alone "daily
deals" business into our traditional eCommerce platform and no longer operating
a stand alone "daily deals" business. As a result, and in order to take
advantage of this opportunity, we have determined that we will no longer operate
a stand-alone "daily deals" business under OnSale. Instead, we have taken the
best practices and technology we have developed in the OnSale daily deals
business and incorporated them into our overall eCommerce offering. Beginning in
the first quarter of 2012, we restored operating and reporting of the OnSale and
MacMall businesses within a single segment. As a result, we now have four
operating segments: SMB, MME, Public Sector and MacMall/OnSale. We include
corporate related expenses such as legal, accounting, information technology,
product management, certain support services and other administrative costs that
are not otherwise allocated to our reportable operating segments in Corporate &
Other. All historical segment financial information provided herein has been
revised to reflect these new reportable operating segments.
During the three months ended September 30, 2012, we generated approximately 38%
of our revenue in our MME segment, 32% of our revenue in our SMB segment, 16% of
our revenue in our Public Sector segment and 14% of our revenue in our
MacMall/OnSale segment. During the nine months ended September 30, 2012, we
generated approximately 40% of our revenue in our MME segment, 33% of our
revenue in our SMB segment, 15% of our revenue in our MacMall/OnSale segment and
12% of our revenue in our Public Sector segment.
Our SMB segment consists of sales made primarily to small and medium sized
businesses, generally with less than 1,000 employees. The SMB segment utilizes
an outbound phone based sales force and, where applicable, a field-based sales
force, together with an online extranet customized for individual customers that
enables them to manage their IT procurement process. In addition, the SMB
segment markets to small businesses through its Small Business Network utilizing
its own social network site at www.pcmallsbn.com.
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--------------------------------------------------------------------------------Our MME segment consists of sales made primarily to mid-market and
enterprise-sized businesses, generally with more than 1,000 employees, under the
SARCOM, NSPI and Abreon brands. The MME segment sells complex products, services
and solutions, utilizing a field relationship-based selling model, an outbound
phone based sales force, a field service 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/OnSale segment consists of sales made under our MacMall brand name
via telephone, the Internet and four retail stores to consumers, small
businesses and creative professionals, and sales made under our OnSale and eCost
brand names via the Internet and inbound phone-based sales forces. The OnSale
business has utilized traditional internet marketing as well as our recently
developed "daily deals" business model.
We experience variability in our net sales and operating results on a quarterly
basis as a result of many factors. We experience some seasonal trends in our
sales of technology products, services and solutions to businesses, government
and educational institutions and individual customers. For example, the timing
of capital budget authorizations for our customers in the small and medium sized
business sector and the mid-market and enterprise sector can affect when these
companies can procure IT products and services. The fiscal year-ends of Public
Sector customers vary for those in the federal government space and those in the
state and local government and educational institution ("SLED") sector. We
generally see an increase in our second quarter sales related to customers in
the SLED sector and in our third quarter sales related to customers in the
federal government space as these customers close out their budgets for their
fiscal year. Also, consumer holiday spending contributes to variances in our
quarterly results. As such, the results of interim periods are not necessarily
indicative of the results that may be expected for any other interim period or
for the full year.
There has been substantial ongoing uncertainty in the global economic
environment and recent disruptions in the capital and credit markets. General
economic conditions have an effect on our business and results of operations
across all of our segments. If economic growth in the U.S. and other countries'
economies slows or declines, government, consumer and business spending rates
could be significantly reduced. These developments could also increase the risk
of uncollectible accounts receivable from our customers. Continued and future
changes and uncertainties in the economic climate in the U.S. and elsewhere
could have a similar negative impact on the rate of information technology
spending of our current and potential customers, which would likely have a
negative impact on our business and results of operations, and could
significantly hinder our growth. These factors could result in reductions in
sales of our products, longer sales cycles, slower adoption of new technologies
and increased price competition, which could materially and adversely affect our
business, results of operations and financial condition. In response to these
uncertainties, we have continued to focus our efforts on cost reduction
initiatives, competitive pricing strategies and driving higher margin service
and solution sales, while continuing to make selective investments in our sales
force personnel, service and solutions capabilities and IT infrastructure and
tools in an effort to position us for enhanced productivity and future growth.
Our planned operating expenditures each quarter are based in large part on sales
forecasts for the quarter. If our sales do not meet expectations in any given
quarter, our operating results for the quarter may be materially adversely
affected. Our narrow gross margins may magnify the impact of these factors on
our operating results. Management regularly reviews our operating performance
using a variety of financial and non-financial metrics including sales,
shipments, gross margin, vendor consideration, advertising expense, personnel
costs, account executive productivity, accounts receivable aging, inventory
turnover, liquidity and cash resources. Our management monitors the various
metrics against goals and budgets, and makes necessary adjustments intended to
enhance our performance.
A substantial portion of our business is dependent on sales of Apple, HP, and
products purchased from other vendors including Adobe, APC,
Cisco, Dell, IBM, Ingram Micro, Lenovo, Microsoft, Tech Data and VMware.
Products manufactured by Apple represented approximately 17% and 16% of our net
sales in the three months ended September 30, 2012 and 2011, and 17% and 20% of
our net sales in the nine months ended September 30, 2012 and 2011. Products
manufactured by HP represented 19% and 22% of our net sales in the three months
ended September 30, 2012 and 2011, and 20% and 21% of our net sales in the nine
months ended September 30, 2012 and 2011.
One element of our business strategy involves expansion through the acquisition
of businesses, assets, personnel or technologies that allow us to complement our
existing operations, expand our market coverage, or add new business
capabilities. While we believe that the fragmented nature of the technology
reseller industry and industry consolidation trends may continue to present
acquisition opportunities for us, these continued trends may make acquisitions
more competitive.
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--------------------------------------------------------------------------------We evaluate acquisition opportunities based on our assessment of several
factors, including the perceived value of the opportunity, our available
financing sources, and potential synergies of the acquisition target with our
business. Our ability to complete acquisitions in the future will depend on our
ability to fund such acquisitions with our internally available cash, cash
generated from operations, amounts available under our existing credit
facilities, additional borrowings or from the issuance of additional securities.
As more fully discussed under "Liquidity and Capital Resources" below, certain
trends in our operating results may impact our available cash resources and
availability under our credit facilities, which in turn may impact our ability
to pursue our acquisition strategy.
STRATEGIC DEVELOPMENTS
Rebranding Strategy and Cost Reduction Initiatives
Over the past several years, our company has grown into approximately a $1.5
billion enterprise in part through our acquisition and internal cultivation of
different brands. We have historically differentiated those brands primarily
based on the identity of the customers they serve. After careful examination of
the trends taking shape in the markets we serve, we have determined that going
forward, our commercial customers can benefit from a more unified and
streamlined brand strategy. We are now consolidating our commercial brands and
realigning our customer segments in an effort to realize significant growth and
to achieve a more efficient cost structure. We believe this unification will
lead to an improved customer experience, operational synergies and benefits to
all of our stakeholders, providing a brand that better represents the technology
solutions provider we are today.
Effective January 1, 2013, we will change the corporate name of PC Mall to
PCM, Inc. and combine our primary commercial subsidiaries PC Mall Sales, Inc.,
Sarcom, Inc. and PC Mall Services, Inc. into a single subsidiary. The combined
subsidiary will operate under the unified commercial brand PCM and will
generally include our SMB, MME and portions of our Corporate & Other segments.
Additionally, in connection with the rebranding, our PC Mall Gov, Inc.
subsidiary will change its name to PCMG, Inc. and will operate under the brand
PCM-G.
An important part of these initiatives is a focused reduction of our overhead
expenses. To that end, we took actions in the first nine months of 2012 that
resulted in annualized cost savings of $7.3 million. These and other related
actions resulted in severance and restructuring related expenses of
approximately $2.5 million in the first nine months of 2012.
ERP and Web Infrastructure Upgrades
We are currently upgrading many of our IT systems. We have purchased licenses
for Microsoft Dynamics AX (Axapta) and other related tools, such as workflow
software, web development tools and other related items, to upgrade our ERP and
eCommerce systems. We initiated the implementation and upgrade of our eCommerce
system in the second half of 2008 and have completed and launched a new
generation of our public sites at macmall.com, onsale.com and pcmall.com. We are
currently working on the implementation of the ERP modules and the upgrade of
the ERP systems, including additional enhancements and features, and we expect
to be completed with a substantial portion of the implementation of the ERP
systems by the end of 2013. We believe the implementation and upgrade should
help us to gain further efficiencies across our organization. While it is
difficult to estimate costs based on the complexity of the systems design,
customization and implementation, based on our estimates, which are subject to
change, we currently expect to incur a cost of approximately $16 million for the
major phases of these IT system upgrades. To date, we have incurred
approximately $13.3 million of such costs. In addition to the above
expenditures, we expect on an ongoing basis to make periodic upgrades to our IT
systems.
Real Estate Transaction
On March 11, 2011, we completed the purchase of real property comprising
approximately 184,000 square feet of land, which includes approximately 84,000
square feet of office space located at 1940 East Mariposa Avenue, El Segundo,
California, which became our new corporate headquarters effective November 14,
2011. We purchased and have improved this building, located strategically
adjacent to the Los Angeles International Airport (LAX), because we want it to
be a compelling destination for customers who want to experience new and cutting
edge IT solutions in person. The new headquarters was designed to drive higher
productivity and efficiency for our employees and to provide a state-of-the-art
demo center for our customers and vendor partners, as well as increase capacity
to support our growth well into the future. In conjunction with the move, we
relocated and substantially upgraded our primary data center from Torrance,
California to our own hosting facility in Atlanta, Georgia, which incorporates
state of the art monitoring and disaster recovery capabilities. As a result of
this relocation certain of our subsidiaries now have geographically redundant
web and information systems. We are in the process of developing a formal
disaster recovery plan for our critical systems.
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eCOST.com Acquisition
On February 18, 2011, we acquired certain assets, including approximately $1
million of inventory, of eCOST.com, a subsidiary of PFSweb, Inc., for $2.3
million. eCOST.com is an online marketplace featuring an assortment of product
categories, including but not limited to computers, networking, electronics and
entertainment, TVs, monitors and projectors, cameras and camcorders, memory and
storage, apparel, and sports and leisure items. The website also features a
proprietary and patented shopping format, Bargain Countdown®, which amongst
other features, offers limited time, limited quantity deals, and supports its
premium online membership shopping club. eCOST.com commenced business in 1999 as
a subsidiary of PC Mall. In September 2004, eCOST.com completed an initial
public offering of approximately 19.8% of its outstanding common stock. In
April 2005, we completed a spin-off of eCOST.com by distributing all of our
remaining ownership interest in eCOST.com to our stockholders. In February 2006,
eCOST.com was acquired by PFSweb in a stock for stock merger.
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, 2011.
Revenue Recognition. We adhere to the revised guidelines and principles of sales
recognition described in ASC 605. Under ASC 605, product sales are recognized
when the title and risk of loss are passed to the customer, there is persuasive
evidence of an arrangement for sale, delivery has occurred and/or services have
been rendered, the sales price is fixed and determinable and collectability is
reasonably assured. Under these guidelines, the majority of our sales, including
revenue from product sales and gross outbound shipping and handling charges, are
recognized upon receipt of the product by the customer. In accordance with our
revenue recognition policy, we perform an analysis to estimate the number of
days products we have shipped are in transit to our customers using data from
our third party carriers and other factors. We record an adjustment to reverse
the impact of sale transactions based on the estimated value of products that
have shipped, but have not yet been received by our customers, and we recognize
such amounts in the subsequent period when delivery has occurred. Changes in
delivery patterns or unforeseen shipping delays beyond our control could have a
material impact on our revenue recognition for the current period.
For all product sales shipped directly from suppliers to customers, we take
title to the products sold upon shipment, bear credit risk, and bear inventory
risk for returned products that are not successfully returned to suppliers;
therefore, these revenues are recognized at gross sales amounts.
Certain software assurance or subscription products and extended warranties that
we sell (for which we are not the primary obligor) are recognized on a net basis
in accordance with ASC 605. Accordingly, such revenues are recognized in net
sales either at the time of sale or over the contract period, based on the
nature of the contract, at the net amount retained by us, with no cost of goods
sold.
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--------------------------------------------------------------------------------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. 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.
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.
Reserve for Inventory Obsolescence. We maintain an allowance for the valuation
of our inventory by estimating obsolete or unmarketable inventory based on the
difference between inventory cost and market value, which is determined by
general market conditions, nature, age and type of each product and assumptions
about future demand. We regularly evaluate the adequacy of our inventory
reserve. If our inventory reserve subsequently proves to be insufficient,
additional allowance may be required.
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 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, using the modified prospective application transition method. ASC
718 addresses the accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for either equity instruments
of the enterprise or liabilities that are based on the fair value of the
enterprise's equity instruments or that may be settled by the issuance of such
equity instruments. ASC 718 generally requires that such transactions be
accounted for using a fair value based method and recognized as expenses in our
Consolidated Statements of Operations.
Pursuant to ASC 718, we estimate the grant date fair value of each stock option
grant awarded pursuant to ASC 718 using the Black-Scholes option pricing model
and management assumptions made regarding various factors, including expected
volatility of our common stock, expected life of options granted and estimated
forfeiture rates, which require extensive use of accounting judgment and
financial estimates. In estimating our assumption regarding expected term for
options we granted during the nine months ended September 30, 2012 and 2011, we
computed the expected term based upon an analysis of historical exercises of
stock options by our employees. We compute our expected volatility using
historical prices of our common stock for a period equal to the expected term of
the options. The risk free interest rate is determined using the implied yield
on U.S. Treasury issues with a remaining term within the contractual life of the
award. We estimate an annual forfeiture rate based on our historical forfeiture
data, which rate will be revised, if necessary, in future periods if actual
forfeitures differ from those estimates. Any material change in the estimates
used in calculating the stock-based compensation expense could result in a
material impact on our results of operations.
Goodwill and Intangible Assets. Goodwill and indefinite-lived intangible assets
are carried at historical cost, subject to write-down, as needed, based upon an
impairment analysis that we perform annually, or sooner if an event occurs or
circumstances change that would more likely than not result in an impairment
loss. We perform our annual impairment test for goodwill and
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--------------------------------------------------------------------------------indefinite-lived intangible assets as of December 31 of each year. Under ASC
350, 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 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.
Fair value is determined by using a weighted combination of a market-based
approach and an income approach, as this combination is deemed to be the most
indicative of fair value in an orderly transaction between market participants.
Under the market-based approach, we utilize 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 determine 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 values of our trademarks are 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 result in an
indication of the pre-tax royalty savings associated with ownership of the
trademarks. Projected after-tax royalty savings are 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) is added.
Given continuing economic uncertainties and related risks to our business, there
can be no assurance that our estimates and assumptions made for purposes of our
goodwill and indefinite-lived intangible assets impairment testing as of
December 31, 2011 will prove to be accurate predictions of the future. We may be
required to record additional goodwill impairment charges in future periods,
whether in connection with our next annual impairment testing as of December 31,
2012 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.
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--------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Consolidated Statements of Operations Data
The following table sets forth, for the periods indicated, our Consolidated
Statements of Operations (in thousands, unaudited) and information derived from
our Consolidated Statements of Operations expressed as a percentage of net
sales. There can be no assurance that trends in our net sales, gross profit or
operating results will continue in the future.
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