• Leveraging the time of experienced Account Managers — Our investments in technology-based sales and service programs allow our Account Managers more time to build and maintain relationships with our customers and help them to solve their business problems.
Additional financial information regarding our business segments is contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of Part II, and Note 16 to our Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
MARKET AND COMPETITION
We generate approximately 58% of our sales from the SMB market, 24% from medium-to-large corporate accounts (Fortune 1000), and 18% from governmental agencies and educational organizations. We estimate the overall U.S. Information Technology market that we serve to be in excess of $200 billion. The largest segment of the market is served by local and regional “value added resellers,” or VARs, many of whom we believe are transitioning from the hardware and software business to IT services, which generally have higher margins.
We have transitioned from an end-user or desktop-centric computing supplier to a network or enterprise-wide computing supplier. We have also partnered with third-party technology and telecommunications service providers. We now offer access to the same services and technical expertise to our customers as local and regional VARs, but with more extensive product selection at lower prices.
Intense competition for customers has led manufacturers of PCs and related products to use all available channels, including direct marketers, to distribute products. Certain manufacturers who have traditionally used resellers to distribute their products have established or attempted to establish their own direct marketing operations, including sales through the Internet. Accordingly, we believe that these manufacturers of PCs and related products will continue to provide us and other third-party direct marketers favorable product allocations and marketing support.
We believe new entrants to the direct marketing channel must overcome a number of obstacles, including:
• the substantial time and resources required to build a customer base of meaningful size, quality, and responsiveness for cost-effective circulation;
• the high costs of developing the information and operating infrastructure required by direct marketers;
• the advantages enjoyed by larger and more established competitors in terms of purchasing and operating efficiencies;
• the difficulty of building relationships with manufacturers to achieve favorable product allocations and attractive pricing terms; and
• the difficulty of identifying and recruiting management personnel with significant direct marketing experience in the industry.
BUSINESS STRATEGIES
Our objective is to become the principal supplier of information technology products and solutions, including personal computers and related products and services, to our customers. The key elements of our business strategies include:
• Providing consistent customer service before, during, and after the sale. We believe that we have earned a reputation for providing superior customer service by consistently focusing on our customers’ needs. We deliver value to our customers through high-quality service and technical support provided by our knowledgeable, well-trained personnel. We also have efficient delivery programs and offer our customers reasonable return policies.
• Offering a broad product selection at competitive prices . We offer our customers a wide assortment of information technology products and solutions, including personal computers and related products and networking products, at competitive prices. Our merchandising programs feature products that provide customers with aggressive price and performance and the convenience of one-stop shopping for their personal computer and related needs.
• Maintaining a strong brand name and customer awareness. Since our founding in 1982, we have built a strong brand name and customer awareness. We have been named to the Fortune 1000 and the VARBusiness 500 for the last five years. Our mailing list includes approximately 3,600,000 names, of which approximately 444,000 have purchased products from us during the last 12 months.
• Maintaining long-standing vendor relationships . We have a history of strong relationships with vendors, and were among the first direct marketers qualified by manufacturers to market computer systems to end users. We provide our vendors with both information concerning customer preferences and an efficient channel for the advertising and distribution of their products.
GROWTH STRATEGIES
Our growth strategies are to increase revenues derived from our penetration of our existing customers, broaden our product offerings, and expand our customer base. The key elements of our growth strategies include:
• Expanding product and service offerings. We continually evaluate information technology products and services focused on business users, adding new products and services as they become available or in response to customer demand. We work closely with vendors to identify and source first-to-market product offerings at aggressive prices, and believe that the expansion of our corporate outbound marketing program will enhance our access to such product offerings. In addition to using our own inventories, we utilize our distribution and manufacturing suppliers to drop ship products directly to our customers. We drop shipped 44% of our net sales in 2005, compared to 38% in 2004.
• Increasing outbound telemarketing productivity . We believe that higher sales productivity is the key to leveraging our expense structure and driving future profitability improvements. We plan to expand and focus our training and evaluation programs, system enhancements, and sales tools more towards assisting our sales personnel in improving their productivity. As we increase our productivity, we plan to increase the number of our corporate account managers and assign them a greater number of our customers.
• Expanding electronic commerce channel. Our Web-based catalog provides detailed product descriptions, product search capabilities, and online order processing. This channel provides our customers with a convenient means of shopping with us, and it also allows us to leverage our account managers more effectively. The number of Internet Business Account users grew from 138,000 at December 31, 2004 to approximately 168,000 at December 31, 2005. We plan to further improve online sales capabilities, including product information and customer service and support available on our Web site.
• Targeting customer segments. Through targeted marketing, we seek to expand the number of our active customers and generate additional sales from these existing customers. We have developed specialty catalogs, as well as standard catalogs with special cover pages, featuring product offerings designed to address the needs of specific customer populations, including new product inserts targeted to purchasers of graphics, server, and networking products.
• Pursuing strategic acquisitions and alliances. We seek acquisitions and alliances that add new customers, strengthen our product offerings, add management talent, and produce operating results which are accretive to our core business earnings. In 2002, we acquired MoreDirect, a premier e-procurement supplier of IT products for medium-to-large corporate organizations nationwide. In October 2005, we acquired selected assets of Amherst Technologies, and as a result, we added approximately 40 former Amherst sales representatives in the fourth quarter of 2005.
SERVICE AND SUPPORT
Since our founding in 1982, our primary objective has been to provide products that meet the demands and needs of customers and to supplement those products with up-to-date product information and excellent customer service and support. We believe that offering our customers superior value, through a combination of product knowledge, consistent and reliable service, and leading products at competitive prices, differentiates us from other direct marketers and provides the foundation for developing a broad and loyal customer base.
We invest in training programs for our service and support personnel, with an emphasis on putting customer needs and service first. We provide toll-free technical support from 9:00 a.m. through 5:30 p.m. Eastern Time, Monday through Friday. Product support technicians assist callers with questions concerning compatibility, installation, determination of defects, and more difficult questions relating to product use. The product support technicians authorize customers to return defective or incompatible products to either the manufacturer or to us for warranty service. In-house technicians perform both warranty and non-warranty repair on most major systems and hardware products.
Using our customized information system, we send our customer orders to our distribution center for processing immediately after a customer receives credit approval. Through our Everything Overnight ® service, orders accepted up until 2:00 a.m. Eastern Time, (until midnight on most custom-configured systems) are generally shipped for overnight delivery via DHL Worldwide. We also configure approximately 20% of the computer systems we ship from our distribution center. Configuration typically consists of the installation of memory, accessories, and/or software.
MARKETING AND SALES
We sell our products through our direct marketing channels to SMBs, government agencies and educational organizations, and medium-to-large corporate accounts. We seek to be the primary supplier of information technology products and solutions, including personal computers and related products, to our existing customers and to expand our customer base. We use multiple marketing approaches to reach existing and prospective customers, including:
• outbound telemarketing and field sales;
• Web and print media advertising;
• marketing programs targeted to specific customer populations; and
• catalogs and inbound telesales.
All of our marketing approaches emphasize our broad product offerings, fast delivery, customer support, competitive pricing, and our increasing range of service solutions.
We believe that our ability to establish and maintain long-term customer relationships and to encourage repeat purchases is largely dependent on the strength of our telemarketing personnel and programs. Because our customers’ primary contact with us is through our telemarketers, we are committed to maintaining a qualified, knowledgeable, and motivated sales staff with its principal focus on customer service.
Sales Channels. The following table sets forth our percentage of net sales by sales channel:
| Years Ended December 31, | |||||||||
| Sales Channel | 2005 | 2004 | 2003 | ||||||
| Outbound Telemarketing and Field Sales |
69 | % | 74 | % | 77 | % | |||
| Online Internet |
26 | 20 | 16 | ||||||
| Inbound Telesales |
5 | 6 | 7 | ||||||
| Total |
100 | % | 100 | % | 100 | % | |||
Outbound Telemarketing and Field Sales. We seek to build loyal relationships with our potential high-volume customers by assigning them to individual account managers. We believe that customers respond favorably to a one-on-one relationship with personalized, well-trained account managers. Once established, these one-on-one relationships are maintained and enhanced through frequent telecommunications and targeted catalogs and other marketing materials designed to meet each customer’s specific IT needs. We pay most of our account managers a base annual salary plus incentive compensation. Incentive compensation is tied to gross profit dollars produced by the individual account manager. Account managers historically have significantly increased productivity after approximately twelve months of training and experience. At December 31, 2005, we employed 618 sales representatives, including 186 with less than twelve months of outbound telemarketing experience with us.
Online Internet. ( www.pcconnection.com, www.govconnection.com, www.macconnection.com, and www.moredirect.com) We provide product descriptions and prices of all products online. Our PC Connection Web site also provides updated information for over 90,000 items and on-screen images for more than 58,000 items. We offer, and continuously update, selected product offerings and other special buys. We believe that our Web sites will be an increasingly important sales source and communication tool for improving customer service.
Inbound Telesales . Our inbound sales representatives answer customer telephone calls generated by our catalogs and other advertising programs. These representatives also assist customers in making purchasing decisions, process product orders, and respond to customer inquiries on order status, product
pricing, and availability. Using our proprietary information systems, sales representatives can quickly access customer records which detail purchase history and billing and shipping information, expediting the ordering process. Our two principal catalogs are PC Connection ® for the PC market and MacConnection ® for the Apple market. In 2005, we published twelve editions of each. We distribute catalogs to purchasers on our in-house mailing list as well as to other prospective customers. In addition, we distribute specialty catalogs to educational and governmental customers and prospects on a periodic basis. We also distribute our monthly catalogs customized with special covers and inserts, offering a wider assortment of special offers on products in specific areas such as graphics, server/netcom, and mobile computing, or for specific customers, such as developers.
Business Segments. We conduct our business operations through three primary business segments: (1) SMB, (2) Large Account, and (3) Public Sector.
SMB Segment . While we continue to generate credit card sales to consumers, our principal target customers in this segment are small-to-medium-sized business customers with 20 to 1,000 employees. Our primary means of marketing to this segment incorporate all three sales channels—outbound telemarketing, primarily to our business customers; inbound telesales, particularly to our consumer group; and online Internet sales to both consumer and business customers.
Large Account Segment . Through our MoreDirect subsidiary’s custom designed Web-based system, we are able to offer our larger corporate customers an efficient and effective method of sourcing, evaluating, purchasing, and tracking a wide variety of IT products and services. MoreDirect’s account managers typically have ten to twenty years of experience and are located strategically across the United States. This allows them to work directly with customers, often on site. MoreDirect generally places all product orders with manufacturers and/or distribution companies for drop shipment directly to its customers.
Public Sector Segment. We use a combination of outbound telemarketing, including some on-site sales solicitation by field sales account managers, and online Internet sales through Internet Business Accounts, to reach these customers. Through our GovConnection subsidiary, we target each of the four distinct market sectors within this segment—federal government, higher educational institutions, school grades K through 12, and state and local governments.
The following table sets forth the relative distribution of our net sales by business segment:
| Years Ended December 31, | |||||||||
| Business Segment |
2005 | 2004 | 2003 | ||||||
| SMB |
58 | % | 59 | % | 57 | % | |||
| Large Account |
24 | 22 | 19 | ||||||
| Public Sector |
18 | 19 | 24 | ||||||
| Total |
100 | % | 100 | % | 100 | % | |||
Specialty Marketing. Our specialty marketing activities include direct mail, other inbound and outbound telemarketing services, bulletin board services, package inserts, fax broadcasts, and electronic mail. We also market call-answering and fulfillment services to certain of our product vendors.
Customers. We maintain an extensive database of customers and prospects currently aggregating approximately 3,600,000 names. Approximately 88% of our net sales in the year ended December 31, 2005 were made to customers who had previously purchased products from us. Except for sales to the federal government, no single customer accounted for more than 2% of our consolidated revenue in 2005. The loss of any single customer will not have a material adverse effect on any of our business segments. In addition, we do not have individual orders in our backlog that are material to our business.
PRODUCTS AND MERCHANDISING
We continuously focus on expanding the breadth of our product offerings. We currently offer our customers over 100,000 information technology products designed for business applications from more than 1,000 manufacturers, including hardware and peripherals, accessories, networking products, and software. We select the products that we sell based upon their technology and effectiveness, market demand, product features, quality, price, margins, and warranties. As part of our merchandising strategy, we also offer products related to PCs, such as digital cameras.
The following table sets forth our percentage of net sales (in dollars) of notebooks and personal digital assistants (“PDAs”), desktops and servers, storage devices, software, networking communications products, printers and printer supplies, video, imaging, and sound, memory and system enhancements, and accessories and other products during the years ended December 31, 2005, 2004, and 2003.
| PERCENTAGE OF NET SALES | |||||||||
| Years Ended December 31, | |||||||||
| 2005 | 2004 | 2003 | |||||||
| Notebooks and PDAs |
18 | % | 21 | % | 20 | % | |||
| Desktops/Servers |
14 | 14 | 15 | ||||||
| Storage Devices |
9 | 8 | 9 | ||||||
| Software |
12 | 12 | 11 | ||||||
| Net/Com Products |
8 | 7 | 8 | ||||||
| Printers and Printer Supplies |
11 | 11 | 11 | ||||||
| Video, Imaging, and Sound |
12 | 12 | 12 | ||||||
| Memory and System Enhancements |
5 | 5 | 5 | ||||||
| Accessories/Other |
11 | 10 | 9 | ||||||
| Total |
100 | % | 100 | % | 100 | % | |||
We offer a 30-day right of return generally limited to defective merchandise. Returns of non-defective products are subject to restocking fees. Substantially all of the products marketed by us are warranted by the manufacturer. We generally accept returns directly from the customer and then either credit the customer’s account or ship the customer a similar product from our inventory.
PURCHASING AND VENDOR RELATIONS
During the year ended December 31, 2005, we purchased approximately 61% of our products from distributors and aggregators and the balance directly from manufacturers. We ship the majority of our purchases directly to our distribution facility in Wilmington, Ohio. During the years ended December 31, 2005, 2004, and 2003, product purchases from Ingram Micro, Inc., our largest vendor, accounted for approximately 26%, 27%, and 22%, respectively, of our total product purchases. Purchases from Tech Data Corporation comprised 19%, 14%, and 15% of our total product purchases in the years ended December 31, 2005, 2004, and 2003, respectively. Purchases from HP constituted 11%, 11%, and 15% of our total product purchases in 2005, 2004, and 2003, respectively. No other vendor accounted for more than 10% of our total product purchases in the years ended December 31, 2005, 2004, and 2003. We believe that alternative sources for products obtained from Ingram Micro, Tech Data, and HP are available to us.
Many product suppliers reimburse us for advertisements or other cooperative marketing programs in our catalogs or advertisements in personal computer magazines that feature a manufacturer’s product. Reimbursements may be in the form of discounts, advertising allowances, and/or rebates. We also receive reimbursements from certain vendors based upon the volume of purchases or sales of the vendors’ products by us.
Some of our vendors offer limited price protection in the form of rebates or credits against future purchases. We may also participate in end-of-life-cycle and other special purchases which may not be eligible for price protection.
We believe that we have excellent relationships with vendors. We generally pay vendors within stated terms and take advantage of all appropriate discounts. We believe that because of our volume purchases we are able to obtain product pricing and terms that are competitive with those available to other major direct marketers. Although brand names and individual product offerings are important to our business, we believe that competitive products are available in substantially all of the merchandise categories offered by us.
DISTRIBUTION
At our approximately 205,000 square foot distribution and fulfillment complex in Wilmington, Ohio, we receive and ship inventory, configure computer systems, and process returned products. Orders are transmitted electronically from our Connecticut, Maryland, Massachusetts, New Hampshire, and Texas sales facilities to our Wilmington distribution center after credit approval, where packing documentation is printed automatically and order fulfillment takes place. Through our Everything Overnight ® service, orders accepted up until 2:00 a.m. Eastern time, (until midnight on custom-configured systems) are generally shipped for overnight delivery via DHL Worldwide Express. We ship approximately 50% of our orders through DHL. Upon request, orders may also be shipped by other common carriers.
We also place product orders directly with manufacturers and/or distribution companies for drop shipment by those manufacturers and/or suppliers directly to customers. Our MoreDirect subsidiary generally places all product orders with manufacturers and/or distribution companies for drop shipment directly to customers. Order status with distributors is tracked online and in all circumstances, a confirmation of shipment from manufacturers and/or distribution companies is received prior to initial recording of the transaction. At the end of each financial reporting period, revenue is adjusted pursuant to Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” to reflect the anticipated receipt of products by the customers in the period. Products dropped shipped by suppliers increased from 38% of net sales in 2004 to 44% of net sales in 2005. In future years, we expect that products drop shipped from suppliers will continue to increase, both in dollars and as a percentage of net sales, as we seek to lower our overall inventory and distribution costs while maintaining excellent customer service.
MANAGEMENT INFORMATION SYSTEMS
All of our subsidiaries, except for MoreDirect, use management information systems, principally comprised of applications software running on IBM AS/400 and RS6000 computers and Microsoft Windows 2003-based servers, which we have customized for our use. These systems permit centralized management of key functions, including order taking and processing, inventory and accounts receivable management, purchasing, sales, and distribution, and the preparation of daily operating control reports on key aspects of the business. We also operate advanced telecommunications equipment to support our sales and customer service operations. Key elements of the telecommunications systems are integrated with our computer systems to provide timely customer information to sales and service representatives, and to facilitate the preparation of operating and performance data.
MoreDirect has developed a custom designed Internet-based system, Traxx ® , which comprises applications software running on Linux and Sun Solaris servers. This system is an integrated application of sales order processing, integrated supply chain visibility, and full EDI links with major manufacturers’ distribution partners for product information, availability, pricing, ordering, delivery, and tracking, including related accounting functions.
We believe that our customized information systems enable us to improve our productivity, ship customer orders on a same-day basis, respond quickly to changes in our industry, and provide high levels of customer service.
Our success is dependent in large part on the accuracy and proper use of our information systems, including our telephone systems, to manage our inventory and accounts receivable collections, to purchase, sell, and ship
