PC Connection 10-Q 2012
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission file number 0-23827
PC CONNECTION, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Former name, former address and former fiscal year, if changed since last report: N/A
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 ¨
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO ¨
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 definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
The number of shares outstanding of the issuers common stock as of August 1, 2012 was 26,451,532.
TABLE OF CONTENTS
PART IFINANCIAL INFORMATION
Item 1Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
See notes to unaudited condensed consolidated financial statements.
PART IFINANCIAL INFORMATION
Item 1Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(amounts in thousands, except per share data)
See notes to unaudited condensed consolidated financial statements.
PART IFINANCIAL INFORMATION
Item 1Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
See notes to unaudited condensed consolidated financial statements
PART IFINANCIAL INFORMATION
Item 1Financial Statements
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except per share data)
Note 1Basis of Presentation
The accompanying condensed consolidated financial statements of PC Connection, Inc. and its subsidiaries (the Company, we, us, or our) have been prepared in accordance with accounting principles generally accepted in the United States of America. Such principles were applied on a basis consistent with the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission (the SEC). The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements contained in our Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods reported and of the Companys financial condition as of the date of the interim balance sheet. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of issuance of these financial statements. The operating results for the three and six months ended June 30, 2012 may not be indicative of the results expected for any succeeding quarter or the entire year ending December 31, 2012.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the amounts reported in the accompanying condensed consolidated financial statements. Actual results could differ from those estimates.
We had no items of comprehensive income, other than our net income for each of the periods presented.
Note 2Earnings Per Share
Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributable to restricted stock units and stock options outstanding, if dilutive.
The following table sets forth the computation of basic and diluted earnings per share:
For the three and six months ended June 30, 2012 and 2011, the following outstanding stock options were excluded from the computation of diluted earnings per share because including them would have had an anti-dilutive effect:
Note 3Other Intangible Assets
At December 31, 2011, our intangible assets included the MoreDirect tradename of $1,190, which had an indefinite life and was not subject to amortization. In the second quarter of 2012, we determined that the tradename had an estimated remaining useful life of five years, and accordingly, we began amortizing the cost of the tradename over a five-year period on a straight-line basis. Our intangible assets and related accumulated amortization are detailed below:
For the three-month periods ended June 30, 2012 and 2011, we recorded amortization expense of $274 and $206, respectively. For the six-month periods ended June 30, 2012 and 2011, we recorded amortization expense of $508 and $263, respectively. The estimated amortization expense in each of the five succeeding years and thereafter is as follows:
Note 4Segment and Related Disclosures
We are required to report profits and losses and certain other information about our reportable operating segments in our annual and interim financial statements. The internal reporting structure used by our chief operating decision maker (CODM) to assess performance and allocate resources determines the basis for our reportable operating segments. Our CODM is our Chairman of the Board of Directors, and she evaluates operations and allocates resources based on a measure of operating income.
Our operations are organized under three reporting segmentsthe SMB segment, which serves primarily small- and medium-sized businesses, consumers, and small office/home office (SOHO) markets; the Large Account segment, which serves primarily medium-to-large corporations; and the Public Sector segment, which serves primarily federal, state, and local government and educational institutions. In addition, the Headquarters/Other group provides services in areas such as finance, human resources, information technology, marketing, and product management. Most of the operating costs associated with the Headquarters/Other group functions are charged to the operating segments based on their estimated usage of the underlying functions. We report these charges to the operating segments as Allocations. Certain headquarters costs relating to executive oversight and other fiduciary functions that are not allocated to the operating segments are included under the heading of Headquarters/Other in the tables below.
In 2011, we managed our Consumer/SOHO business as a separate operating segment. Effective January 1, 2012, we merged our Consumer/SOHO business into our SMB business to better serve the Consumer/SOHO customers and improve operating efficiencies. We have revised the reporting of operating segments to reflect the new basis for assessing performance
and allocating resources. Under this revised reporting structure, the operating results related to our consumer and SOHO customers that were formerly reported separately are now included within the SMB segment. We have restated prior year segment information to conform to our revised segment reporting structure.
On March 17, 2011, we acquired ValCom, a provider of IT infrastructure and on-site managed services to medium-to-large corporations, and have included its operating results in our Large Account segment from the date of the acquisition. For the six-month periods ended June 30, 2012 and 2011, we reported external sales for ValCom of $20,207 and $8,777, respectively, which were immaterial to our consolidated results. The operating results of ValCom for the six months ended June 30, 2012 and 2011 were also immaterial to our consolidated results.
Net sales presented below exclude inter-segment product revenues. Segment information applicable to our reportable operating segments for the three and six months June 30, 2012 and 2011 is shown below:
The assets held by our operating segments are primarily accounts receivables, intercompany receivables, goodwill, and other intangibles. Assets reported under the Headquarters/Other group are managed by corporate headquarters, including cash, inventory, and property and equipment, and are presented net of intercompany balance eliminations of $41,778 as of June 30, 2012. Our capital expenditures are comprised largely of IT hardware and software purchased to maintain or upgrade our management information systems. These systems serve all of our subsidiaries, to varying degrees, and as a result, our CODM does not evaluate capital expenditures on a segment basis.
Senior management also monitors consolidated revenue by product mix (Notebook; Software; Desktop/Server; Net/Com Product; Video, Imaging and Sound; Storage; Printer and Printer Supplies; Memory and System Enhancement; and Accessory/Other).
Net sales by product mix is presented below:
Note 5Commitments and Contingencies
We are subject to various legal proceedings and claims, including patent infringement claims, which have arisen during the ordinary course of business. In the opinion of management, the outcome of such matters is not expected to have a material effect on our financial position, results of operations, and cash flows.
We are subject to audits by states on sales and income taxes, unclaimed property, employment matters, and other assessments. A comprehensive multi-state unclaimed property audit continues to be in progress. While we believe we have adequately provided for known and estimated liabilities, it is too early to determine the ultimate outcome of such audits, as no formal assessments have yet been made. Additional liabilities for this and other audits could be assessed, and such outcomes could have a material, negative impact on our financial position, results of operations, and cash flows.
Note 6Bank Borrowing and Trade Credit Arrangements
We have a $50,000 credit facility that expires in February 2017. The loan is collateralized by receivables, and has no restrictions on the repurchase of our common stock or the payment of dividends. This facility can be increased, at our option, to $80,000 for approved acquisitions or other uses authorized by the lender at substantially the same terms. Amounts outstanding under this facility bear interest at the one-month London Interbank Offered Rate, or LIBOR, plus a spread based on our funded debt ratio, or in the absence of LIBOR, the prime rate (3.25% at June 30, 2012). The one-month LIBOR rate at June 30, 2012 was 0.24%. The credit facility includes various customary financial ratios and operating covenants, including minimum net worth and maximum funded debt ratio requirements, and default acceleration provisions, none of which we believe significantly restricts our operations. Funded debt ratio is the ratio of average outstanding advances under the credit facility to Adjusted EBITDA (Earnings Before Interest Expense, Taxes, Depreciation, Amortization, and Special Charges). The maximum allowable funded debt ratio under the agreement is 2.0 to 1.0. Decreases in our consolidated Adjusted EBITDA could limit our potential borrowings under the credit facility. We had no outstanding bank borrowings during the second quarter of 2012, and accordingly, the entire $50,000 facility was available for borrowings under the credit facility.
At June 30, 2012, we had security agreements with two financial institutions to facilitate the purchase of inventory from various suppliers under certain terms and conditions. The agreements allow a collateralized first position in certain branded products in our inventory financed by the financial institutions up to an aggregated amount of $47,000. The cost of such financing under these agreements is borne by the suppliers by discounting their invoices to the financial institutions. We do not pay any interest or discount fees on such inventory. At June 30, 2012 and December 31, 2011, accounts payable included $24,707 and $22,827, respectively, owed to these financial institutions.
Note 7Treasury Stock Purchases
On March 28, 2001, our Board of Directors authorized the spending of up to $15,000 to repurchase our common stock. We consider block repurchases directly from larger shareholders, as well as open market purchases, in carrying out our ongoing stock repurchase program.
In the six months ended June 30, 2012, we repurchased 162 shares for $1,466. As of June 30, 2012, we have repurchased an aggregate of 1,682 shares for $12,233, and the maximum approximate dollar value of shares that may yet be purchased under the board authorization is $2,767. During the six months ended June 30, 2012, we issued upon the vesting of restricted stock 125 shares from treasury with a fair value of $926 and have reflected the net remaining balance of treasury stock on the condensed consolidated balance sheet. In connection with the vesting, we withheld 36 shares, having an aggregate fair value
of $308, to satisfy related statutory withholding obligations. These net-share settlements had the economic effect of repurchases of common stock as they reduced the number of shares that would have otherwise been issued as a result of the vesting. The shares withheld were returned to treasury but did not apply against authorized repurchase limits under our Board of Directors authorization.
Note 8Fair Value
Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, and a contingent liability related to the ValCom acquisition. The carrying values of cash, accounts receivable, and accounts payable approximate their fair values due to their short-term nature.
We are required to measure fair value under a fair value hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. A financial instruments categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:
Level 1Quoted prices in active markets for identical assets or liabilities.
Level 2Include other inputs that are directly or indirectly observable in the marketplace.
Level 3Unobservable inputs which are supported by little or no market activity.
We measure our cash equivalents at fair value and classify such assets within Level 1 of the fair value hierarchy. This classification has been determined based on the manner in which we value our cash equivalents, primarily using quoted market prices for identical assets. The Level 3 liability consists of contingent consideration related to our acquisition of ValCom in the first quarter of 2011. The fair value of the contingent consideration was estimated by applying the income approach, which utilizes significant inputs that are unobservable in the market. Key assumptions used at the initial valuation date included a discount rate of 4.8% and a 100% probability of achievement. There have been no significant changes in those assumptions since the initial valuation date. In the second quarter of 2011, we paid the first $1,000 of the contingent consideration. In April 2012, we made a second payment of $1,000, which was initially valued at $960 at the date of the acquisition and has been increased by $40, representing the change in fair value over the period from acquisition to the payment date. The third and final payment of up to $1,000 is expected to be paid in the fourth quarter of 2012 upon achievement of the last revenue milestone.
A roll forward of Level 3 liabilities is as follows:
Assets and liabilities measured at fair value on a recurring basis consisted of the following types of instruments at June 30, 2012 and December 31, 2011:
Note 9Special Charges
In the first six months of 2012, we recorded special charges of $1,135 related to awards granted upon the retirement of a former executive officer and certain workforce reductions. We did not record any such charges in the six months ended June 30, 2011. A roll forward of the liability for these charges is shown below.
The issuance of nonvested stock for $842 was a non-cash charge. The remaining obligation of $37 is included in accrued payroll on the condensed consolidated balance sheet.
PART IFINANCIAL INFORMATION
Item 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Our managements discussion and analysis of our financial condition and results of operations include the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated. See Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011 on file with the SEC.
We are a leading direct marketer of a wide range of information technology, or IT, solutions. We help companies design, enable, manage, and service their IT environments. We provide IT products, including computer systems, software and peripheral equipment, networking communications, and other products and accessories that we purchase from manufacturers, distributors, and other suppliers. We also offer an extensive range of services involving design, configuration, and implementation of IT solutions. These services are performed by our personnel and by third-party providers. We operate through three sales segments, which serve primarily: (a) small- to medium-sized businesses and consumers and small office/home office (SOHO) customers, in SMB, through our PC Connection Sales subsidiary, (b) large enterprise customers, in Large Account, through our MoreDirect and ValCom Technology (ValCom) subsidiaries, and (c) federal, state, and local government and educational institutions, in Public Sector, through our GovConnection subsidiary.
We generate sales primarily through outbound telemarketing and field sales contacts by account managers focused on the business, education, and government markets, our websites, and inbound calls from customers responding to our catalogs and other advertising media. We seek to recruit, retain, and increase the productivity of our sales personnel through training, mentoring, financial incentives based on performance, and updating and streamlining our information systems to make our operations more efficient.
As a value added reseller in the IT supply chain, we do not manufacture IT hardware or software. We are dependent on our suppliersmanufacturers and distributors that historically have sold only to resellers rather than directly to end users. However, certain manufacturers have on multiple occasions attempted to sell directly to our customers, and in some cases, have restricted our ability to sell their products directly to certain customers, thereby attempting to eliminate our role. We believe that the success of these direct sales efforts by suppliers will depend on their ability to meet our customers ongoing demands and provide objective, unbiased solutions to meet their needs. We believe more of our customers are seeking complete IT solutions, rather than simply the acquisition of specific IT products. Our advantage is our ability to be product-neutral and provide a broader combination of products, services, and advice tailored to customer needs. By providing customers with customized solutions from a variety of manufacturers, we believe we can mitigate the negative impact of continued direct sales initiatives from individual manufacturers. Through the formation of our ProConnection services group, and our acquisition of ValCom, we are able to provide customers complete IT solutions, from identifying their needs, to designing, developing, and managing the integration of products and services to implement their IT projects. Such service offerings carry higher margins than traditional product sales. Additionally, the technical certifications of our service engineers permit us to offer higher-end, more complex products that generally carry higher gross margins. We expect these service offerings and technical certifications to continue to play a role in sales generation and improve gross margins in this competitive environment.
Market conditions and technology advances significantly affect the demand for our products and services. Virtual delivery of software products and advanced Internet technology providing customers enhanced functionality have substantially increased customer expectations, requiring us to invest more heavily in our own IT development to meet these new demands. This investment includes significant expenditures to update our websites. As buying trends change and electronic commerce continues to grow, customers have become more sophisticated due to the amount and quality of information available and the increased number of readily available choices. Customers are also better able to make price comparisons through the Internet, thereby necessitating more aggressive pricing strategies to remain competitive. While it is not possible for us to estimate with any degree of accuracy the level of sales we may have lost or may lose in the future as a result of such increased buyer sophistication, our consolidated Internet sales have consistently represented between 30%35% of net sales over the last three years and our gross profit margins have generally increased year over year for the past two years.
The primary challenges we continue to face in effectively managing our business are (1) increasing our revenues while at the same time maintaining or improving our gross margin in all three segments, (2) recruiting, retaining, and improving the productivity of our sales personnel, and (3) effectively controlling our selling, general, and administrative, or SG&A, expenses while making major investments in our IT systems and solution selling personnel.
To support future growth, we continue to expand our ability to deliver complete IT solutions, which requires the addition of highly-skilled service engineers. We are still in the stages of this multi-year initiative, and, although we expect to realize the ultimate benefit of higher-margin service revenues, we believe that our SG&A expenses will continue to increase as we add service engineers. If our service revenues do not grow enough to offset the cost of these headcount additions, our operating results may decline.
To operate more efficiently, we have undertaken a comprehensive review and assessment of our entire business software needs. That review and assessment includes the review of commercially available software that meets, or can be configured to meet, those needs better than our existing software. As of June 30, 2012, we have capitalized $10.8 million of software and integration costs for the initial phase of this software project. While we have not yet finalized our decisions regarding to what extent additional software will be acquired and implemented beyond the Customer Master Data Management (MDM) software we have acquired to date, we expect to increase our capital investments in our IT infrastructure in the next three years, which will also likely increase SG&A expenses. In addition, when the Customer MDM software is placed into service, we expect depreciation expense to increase by $2.0 million on an annual basis.
Effective January 1, 2012, we merged our Consumer/SOHO segment into our SMB segment to better serve the Consumer/SOHO customers and to achieve operating efficiencies. We have revised the reporting of operating segments to reflect the new basis for assessing performance and allocating resources. Under this revised reporting structure, the operating results related to our consumer and SOHO customers that were formerly reported separately are now included within the SMB segment. We have restated prior year segment information to conform to our revised segment reporting structure.
RESULTS OF OPERATIONS
The following table sets forth information derived from our statements of income expressed as a percentage of net sales for the periods indicated:
Net sales in the second quarter of 2012 increased by $30.0 million, or 5.9%, compared to the second quarter of 2011. Slight declines in net sales for both our SMB and Public Sector were more than offset by a 22.5% increase in Large Account sales. As noted above, we combined our SMB and Consumer/SOHO segments on January 1, 2012. Excluding sales to our consumer and SOHO customers, SMB sales would have increased by 3.5% year over year, however, when combined with lower consumer and SOHO sales, overall sales decreased by 1.1%. Improvements in gross margin (gross profit expressed as a percentage of net sales) for both our SMB and Public Sector segments resulted in an overall margin improvement. SG&A expenses increased in dollars due to investments in internal systems projects and incremental variable compensation, but improved as a percentage of net sales. Operating income in the second quarter of 2012 increased year over year by $2.3 million to $14.7 million due to the increase in net sales and gross margin.
Net sales in the six months ended June 30, 2012 increased by $66.8 million, or 6.9%, compared to the six months ended June 30, 2011. Net sales for our SMB and Public Sector segments decreased slightly in the first six months of 2012 compared to the prior year period, while our Large Account revenues increased by 23.0%. SMB sales would have increased by 3.7% excluding sales to our consumer and SOHO customers, however, when combined with lower consumer and SOHO sales, overall sales decreased by 0.4%. Excluding ValCom sales for the six-month periods ended 2012 and 2011, our consolidated net sales would have increased by 5.7% year over year. Gross margin (gross profit expressed as a percentage of net sales) increased in all three segments in the six months ended June 30, 2012 as compared to the prior year period due to increased sales of higher-margin IT solutions and incremental vendor consideration as a percentage of net sales. Operating income in the six months ended June 30, 2012 increased year over year by $3.7 million to $23.7 million due to the increase in net sales and gross margin.
Net Sales Distribution
The following table sets forth our percentage of net sales by business segment and product mix:
The following table summarizes our gross margin, as a percentage of net sales, over the periods indicated:
Consolidated gross profit dollars for the three and six months ended June 30, 2012 increased year over year due to an increase in net sales and gross margin compared to the respective prior year periods. On a consolidated basis, gross margin increased year over year in each of the three and six-month periods ended June 30, 2012, due to our focus on increasing sales of higher-margin product and service solutions.
Cost of Sales and Certain Other Costs
Cost of sales includes the invoice cost of the product, direct employee and third party cost of services, direct costs of packaging, inbound and outbound freight, and provisions for inventory obsolescence, adjusted for discounts, rebates, and other vendor allowances. Direct operating expenses relating to our purchasing function and receiving, inspection, internal transfer, warehousing, packing and shipping, and other expenses of our distribution center are included in our SG&A expenses. Accordingly, our gross margin may not be comparable to those of other entities that include all of the costs related to their distribution network in cost of goods sold. Such distribution costs included in our SG&A expenses, as a percentage of net sales for the periods reported, are as follows:
The following table breaks out our more significant operating, or SG&A, expenses for the periods indicated (dollars in millions):
Personnel costs increased year over year in the three and six months ended June 30, 2012, due primarily to investments in solutions sales and support areas and incremental variable compensation associated with higher gross profits. The ValCom acquisition also added to the increase in personnel costs in the six months ended June 30, 2012.
Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
Changes in net sales and gross profit by business segment are shown in the following table (dollars in millions):
Net sales increased on a consolidated basis in the second quarter of 2012 compared to the second quarter of 2011, as explained below:
Gross profit for the second quarter of 2012 increased on a consolidated basis year over year in dollars and as a percentage of net sales (gross margin), as explained below:
Selling, general and administrative expenses increased in dollars but decreased as a percentage of net sales on a consolidated basis in the second quarter of 2012 compared to the prior year quarter. SG&A expenses attributable to our three operating segments and the remaining unallocated Headquarters/Other group expenses are summarized below (dollars in millions):
Income from operations for the second quarter of 2012 increased to $14.7 million, compared to $12.4 million for the second quarter of 2011. Income from operations as a percentage of net sales was 2.7% for the second quarter of 2012, compared to 2.4% of net sales for the prior year quarter. The increases in operating income and operating margin resulted primarily from the respective increase in sales and gross margin.
Our effective tax rate was 39.4% for the second quarter of 2012 compared to an effective tax rate of 39.5% for the second quarter of 2011. Our tax rate will continue to vary based on variations in state tax levels for certain subsidiaries, valuation reserves, and accounting for uncertain tax positions, however we do not expect these variations to be significant for the rest of 2012.
Net income for the second quarter of 2012 increased to $8.8 million, compared to $7.5 million for the second quarter of 2011, principally due to the increase in operating income.
Six Months Ended June 30, 2012 Compared to Six Months Ended 30, 2011
Changes in net sales and gross profit by business segment are shown in the following table (dollars in millions):
Net sales for the six months ended June 30, 2012 increased on a consolidated basis compared to the six months ended June 30, 2011, as explained below:
Gross profit for the six months ended June 30, 2012 increased in dollars and as a percentage of net sales (gross margin) on a consolidated basis compared to the six months ended June 30, 2011, as explained below:
Selling, general and administrative expenses in the six months ended June 30, 2012 increased in dollars, but was unchanged as a percentage of net sales compared to the six months ended June 30, 2011. The year-over-year changes attributable to our operating segments and the Headquarters/Other group are summarized below (dollars in millions):
Special charges totaled $1.1 million in the six months ended June 30, 2012 and were related to the retirement of a former executive officer, as well as workforce reductions. We did not record any such charges in the six months ended June 30, 2011.
Income from operations for the six months ended June 30, 2012 increased to $23.7 million, or 2.3% of net sales, compared to $19.5 million, or 2.0% of net sales for the comparable prior year period. Our increase in operating income and operating margin in the six months ended June 30, 2012 resulted primarily from the increase in net sales and gross margin, compared to the prior year period.
Our effective tax rate was 39.5% for the six months ended June 30, 2012 compared to the effective tax rate of 39.9% for the prior year period of 2011. Our tax rate will continue to vary based on variations in state tax levels for certain subsidiaries, valuation reserves, and accounting for uncertain tax positions, however we do not expect these variations to be significant in 2012.
Net income for the six months ended June 30, 2012 increased to $14.3 million, compared to $12.0 million for the six months ended June 30, 2011, principally due to the year-over-year increase in operating income in the first six months of 2012.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been internally generated funds from operations and borrowings under our bank line of credit. We have used those funds to meet our capital requirements, which consist primarily of working capital for operational needs, capital expenditures for computer equipment and software used in our business, repurchases of common stock for treasury, and as opportunities arise, acquisitions of new businesses.
We believe that funds generated from operations, together with available credit under our bank line of credit and inventory trade credit agreements, will be sufficient to finance our working capital, capital expenditures, and other requirements for at least the next twelve calendar months. Aside from our expenditures on the Customer MDM software initiative, we expect our capital needs for the next twelve months to consist primarily of capital expenditures of $9.0 to $12.0 million and payments on capital lease and other contractual obligations of approximately $4.0 million. In addition, we are currently in the midst of a comprehensive review and assessment of our entire business software needs. That review and assessment includes the review of commercially available software that meets, or can be configured to meet, those needs better than our existing software. While we have not finalized our decisions regarding to what extent new software will be acquired and implemented beyond the Customer MDM software we have acquired to date, the additional capital costs of such a project, if fully implemented, would likely exceed $20.0 million over the next three years. As of June 30, 2012, we have capitalized $10.8 million of software and integration costs for the Customer MDM software project, the first stage of our overall IT initiative, of which $2.5 million was capitalized in the first six months of 2012.
We expect to meet our cash requirements for the next twelve months through a combination of cash on hand, cash generated from operations and, if necessary, borrowings on our bank line of credit, as follows:
Our ability to continue funding our planned growth, both internally and externally, is dependent upon our ability to generate sufficient cash flow from operations or to obtain additional funds through equity or debt financing, or from other sources of financing, as may be required. While at this time, we do not anticipate needing any additional sources of financing to fund our operations, if demand for information technology products declines, our cash flows from operations may be substantially affected. See more about this and related risks listed under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011.
Summary of Sources and Uses of Cash
The following table summarizes our sources and uses of cash over the periods indicated (in millions):
Cash provided by operating activities increased by $39.2 million in the six months ended June 30, 2012, compared to the prior year period. Operating cash flow in the six months ended June 30, 2012, resulted primarily from net income before depreciation and amortization, an increase in payables, and a decrease in receivables. Accounts receivable decreased by $41.5 million from the prior year-end balance due to improved collections as days sales outstanding decreased to 41 days at June 30, 2012, compared to 47 days at December 31, 2011. Inventory decreased from the prior year-end balance by $2.5 million. Inventory turns increased to 28 turns for the second quarter of 2012 compared to 25 turns for the prior year quarter.
At June 30, 2012, we had $138.2 million in outstanding accounts payable. Such accounts are generally paid within 30 days of incurrence, or earlier when favorable cash discounts are offered. This amount includes $24.7 million payable to two financial institutions under inventory trade credit agreements we use to finance our purchase of certain inventory, secured by the inventory so financed. We believe we will be able to meet these obligations with cash flows from operations and our existing line of credit.
Cash used for investing activities decreased by $6.1 million in the six months ended June 30, 2012 compared to the prior year period primarily due to our cash purchase of ValCom in the first half of 2011 which represented a net cash investment of $4.7 million. Cash used to purchase property and equipment amounted to $5.2 million in the first six months of 2012, compared to $6.1 million in the prior year period. These expenditures were primarily for computer equipment and capitalized internally-developed software in connection with the IT initiative referred to in the above Liquidity and Capital Resources section.
Cash used for financing activities in the six months ended June 30, 2012 increased by $6.4 million compared to the prior year period. The increase was due primarily due to the repayment in the first quarter of 2012 of $5.3 million in borrowings on our bank line of credit. In addition, we also paid $1.0 million in contingent consideration for the achievement of the second of three milestones for the ValCom acquisition. We expect to pay up to an additional $1.0 million in contingent consideration for the remaining milestone in the fourth quarter of 2012. We withheld 36,213 shares, having a fair value of $0.3 million, upon the vesting of stock awards to satisfy related tax obligations during the six months ended June 30, 2012. Our treasury stock purchases were comparable to the prior year period, however we continue to consider block repurchases directly from larger stockholders, as well as open market purchases, in carrying out our ongoing stock repurchase program.
Debt Instruments, Contractual Agreements, and Related Covenants
Below is a summary of certain provisions of our credit facilities and other contractual obligations. For more information about the restrictive covenants in our debt instruments and inventory financing agreements, see Factors Affecting Sources of Liquidity below. For more information about our obligations, commitments, and contingencies, see our condensed consolidated financial statements and the accompanying notes included in this Quarterly Report.
Bank Line of Credit. Our bank line of credit extends until February 2017 and is collaterized by our receivables. Our borrowing capacity is up to $50.0 million at the one-month London Interbank Offered Rate, or LIBOR, plus a spread based on our funded debt ratio, or in the absence of LIBOR, the prime rate (3.25% at June 30, 2012). The one-month LIBOR rate at June 30, 2012 was 0.24%. In addition, we have the option to increase the facility by an additional $30.0 million, based on sufficient levels of trade receivables to meet borrowing base requirements, and depending on meeting minimum Adjusted EBITDA (earnings before interest, taxes, depreciation, amortization, and special charges) and equity requirements, described below under Factors Affecting Sources of Liquidity. Borrowings under the credit facility during the six months of 2012 were minimal in amount and duration and were utilized to facilitate short-term working capital requirements in the first quarter of 2012.
This facility operates under an automatic cash management program whereby disbursements in excess of available cash are added as borrowings at the time disbursement checks clear the bank, and available cash receipts are first applied against any outstanding borrowings and then invested in short-term qualified cash investments. Accordingly, borrowings under the line are classified as current. At June 30, 2012, the entire $50.0 million facility was available for borrowing.
Inventory Trade Credit Agreements. We have additional security agreements with two financial institutions to facilitate the purchase of inventory from various suppliers under certain terms and conditions. These agreements allow a collateralized first position in certain branded products in our inventory that were financed by these two institutions. Although the agreements provide for up to 100% financing on the purchase price of these products, up to an aggregate of $47.0 million, any outstanding financing must be fully secured by available inventory. We do not pay any interest or discount fees on such inventory. The related costs are borne by the suppliers as an incentive for us to purchase their products. Amounts outstanding under such facilities, which equaled $24.7 million in the aggregate as of June 30, 2012, are recorded in accounts payable. The inventory financed is classified as inventory on the condensed consolidated balance sheet.
Capital Leases. We have a fifteen-year lease for our corporate headquarters with an affiliated company related through common ownership. In addition to the rent payable under the facility lease, we are required to pay real estate taxes, insurance, and common area maintenance charges. The initial term of the lease expires in 2013, and we have the option to renew the lease for two additional terms of five years each.
Operating Leases. We lease facilities from our principal stockholders and facilities and equipment from third parties under non-cancelable operating leases which have been reported in the Contractual Obligations section of our Annual Report on Form 10-K for the year ended December 31, 2011.
Sports Marketing Commitments. We have entered into multi-year sponsorship agreements with the New England Patriots and the Boston Red Sox that extend to 2013 and 2014, respectively. These agreements, which grant us various marketing rights and seating access, require annual payments aggregating from $0.1 million to $0.4 million per year.
Off-Balance Sheet Arrangements. We do not have any other off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition or changes in financial condition.
Contractual Obligations. The disclosures relating to our contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2011 have not materially changed since the report was filed.
Factors Affecting Sources of Liquidity
Internally Generated Funds. The key factors affecting our internally generated funds are our ability to minimize costs and fully achieve our operating efficiencies, timely collection of our customer receivables, and management of our inventory levels.
Bank Line of Credit. Our credit facility contains certain financial ratios and operational covenants and other restrictions (including restrictions on additional debt, guarantees, investments, and liens) with which we, and all of our subsidiaries, must comply. Any failure to comply with these covenants would constitute as a default and could prevent us from borrowing additional funds under this line of credit. This credit facility contains two financial tests:
Inventory Trade Credit Agreements. These agreements contain similar financial ratios and operational covenants and restrictions as those contained in our bank line of credit described above. These agreements also contain cross-default provisions whereby a default under the bank agreement would also constitute a default under these agreements. Financing under these agreements is limited to the purchase of specific branded products from authorized suppliers, and amounts outstanding must be fully collateralized by inventories of those products on hand.
Capital Markets. Our ability to raise additional funds in the capital market depends upon, among other things, general economic conditions, the condition of the information technology industry, our financial performance and stock price, and the state of the capital markets.
SUMMARY OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies have not materially changed from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011. These policies include revenue recognition, accounts receivable, vendor allowances, value of goodwill and long-lived assets, including intangibles, and inventory.
We have historically offset any inflation in operating costs by a combination of increased productivity and price increases, where appropriate. We do not expect inflation to have a significant impact on our business in the foreseeable future.
PART IFINANCIAL INFORMATION
Item 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a description of the Companys market risks, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. No material changes have occurred in our market risks since December 31, 2011.
PART IFINANCIAL INFORMATION
Item 4CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2012. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives as described above. Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2012, our disclosure controls and procedures were effective at the reasonable assurance level.
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 fiscal quarter ended June 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 1ARisk Factors
In addition to other information set forth in this report, you should carefully consider the factors discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial position, and results of operations. Risk factors which could cause actual results to differ materially from those suggested by forward-looking statements include but are not limited to those discussed or identified in this document, in our public filings with the SEC, and those incorporated by reference in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011.
Item 2Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about our purchases during the quarter ended June 30, 2012, of equity securities that we have registered pursuant to Section 12 of the Exchange Act:
ISSUER PURCHASES OF EQUITY SECURITIES
Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011, (ii) Condensed Consolidated Statements of Income for the three and six months ended June 30, 2012 and June 30, 2011, (iii) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and June 30, 2011, and (v) Notes to Unaudited Condensed Consolidated Financial Statements.
In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act, is deemed not filed for purposes of section 18 of the Exchange Act, and otherwise is not subject to liability under these sections.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.