UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington
, D.C. 20549
FORM
10-Q
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2008
OR
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE TRANSITION PERIOD FROM __________ TO
__________
|
Commission
File Number 0-28488
ZONES,
INC
(Exact
name of registrant as specified in its charter)
Washington
|
91-1431894
|
(State
of Incorporation)
|
(I.R.S.
Employer
Identification
Number)
|
1102
15
th
Street SW, Suite 102
|
|
Auburn,
Washington
|
98001-6509
|
(Address
of Principal Executive Offices)
|
(Zip
Code)
|
(253)
205-3000
(Registrant's
Telephone
Number,
Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes
x
No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated filer
o
|
Accelerated
filer
o
|
Non-accelerated
filer
o
|
Smaller
reporting company
x
|
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes
o
No
x
The
number of shares of the registrant's Common Stock outstanding as of August 6,
2008 was 13,226,553.
ZONES, INC.
INDEX
PART
I. FINANCIAL INFORMATION
Item
1.
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
4
|
|
|
|
|
|
5
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|
|
|
|
6
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|
|
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|
|
7
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|
|
|
Item
2.
|
|
12
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|
|
|
Item
3.
|
|
19
|
|
|
|
Item
4.
|
|
19
|
|
|
|
PART
II. OTHER INFORMATION
|
|
|
|
Item
1.
|
|
|
|
|
|
Item
1A.
|
|
19
|
|
|
|
Item
2.
|
|
25
|
|
|
|
Item
4.
|
|
25
|
|
|
|
Item
6.
|
|
26
|
|
|
|
|
|
26
|
Part I.
Item 1.
Financial
Statements
ZONES, INC.
CONSOLIDATED
BALANCE SHEETS
(in
thousands)
(unaudited)
|
|
June 30,
|
|
|
December 31,
|
|
ASSETS
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
17,111
|
|
|
$
|
12,004
|
|
Receivables,
net of allowances of $1,329 and $1,213
|
|
|
67,359
|
|
|
|
73,581
|
|
Vendor
receivables, net of allowances of $833 and $780
|
|
|
11,071
|
|
|
|
15,139
|
|
Inventories
|
|
|
20,271
|
|
|
|
21,278
|
|
Prepaid
expenses
|
|
|
942
|
|
|
|
861
|
|
Deferred
income taxes
|
|
|
1,377
|
|
|
|
1,377
|
|
Total
current assets
|
|
|
118,131
|
|
|
|
124,240
|
|
Property
and equipment, net
|
|
|
3,286
|
|
|
|
3,383
|
|
Goodwill
|
|
|
5,098
|
|
|
|
5,098
|
|
Deferred
income taxes
|
|
|
411
|
|
|
|
411
|
|
Other
assets
|
|
|
191
|
|
|
|
190
|
|
Total
assets
|
|
$
|
127,117
|
|
|
$
|
133,322
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
33,223
|
|
|
$
|
37,040
|
|
Inventory
financing
|
|
|
13,169
|
|
|
|
20,252
|
|
Accrued
liabilities
|
|
|
10,648
|
|
|
|
11,989
|
|
Total
current liabilities
|
|
|
57,040
|
|
|
|
69,281
|
|
Deferred
rent obligation
|
|
|
1,614
|
|
|
|
1,733
|
|
Total
liabilities
|
|
|
58,654
|
|
|
|
71,014
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders'
equity:
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
35,629
|
|
|
|
35,676
|
|
Retained
earnings
|
|
|
32,837
|
|
|
|
26,632
|
|
Accumulated
other comprehensive loss
|
|
|
(3
|
)
|
|
|
|
|
Total
shareholders' equity
|
|
|
68,463
|
|
|
|
62,308
|
|
Total
liabilities and shareholders' equity
|
|
$
|
127,117
|
|
|
$
|
133,322
|
|
See notes
to consolidated financial statements
ZONES, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands, except per share data)
(unaudited)
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
158,333
|
|
|
$
|
192,232
|
|
|
$
|
325,089
|
|
|
$
|
340,414
|
|
Cost
of sales
|
|
|
137,531
|
|
|
|
169,813
|
|
|
|
284,723
|
|
|
|
299,795
|
|
Gross
profit
|
|
|
20,802
|
|
|
|
22,419
|
|
|
|
40,366
|
|
|
|
40,619
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
13,333
|
|
|
|
12,797
|
|
|
|
27,151
|
|
|
|
25,394
|
|
Advertising
expenses
|
|
|
1,822
|
|
|
|
2,243
|
|
|
|
3,565
|
|
|
|
4,126
|
|
Income
from operations
|
|
|
5,647
|
|
|
|
7,379
|
|
|
|
9,650
|
|
|
|
11,099
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
(income) expense, net
|
|
|
(139
|
)
|
|
|
239
|
|
|
|
(243
|
)
|
|
|
215
|
|
Income
before taxes
|
|
|
5,786
|
|
|
|
7,140
|
|
|
|
9,893
|
|
|
|
10,884
|
|
Provision
for income taxes
|
|
|
2,160
|
|
|
|
2,731
|
|
|
|
3,688
|
|
|
|
4,164
|
|
Net
income
|
|
$
|
3,626
|
|
|
$
|
4,409
|
|
|
$
|
6,205
|
|
|
$
|
6,720
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income per share
|
|
$
|
0.27
|
|
|
$
|
0.34
|
|
|
$
|
0.47
|
|
|
$
|
0.51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing basic income per share
|
|
|
13,186
|
|
|
|
13,127
|
|
|
|
13,171
|
|
|
|
13,132
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
income per share
|
|
$
|
0.25
|
|
|
$
|
0.30
|
|
|
$
|
0.43
|
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used in computing diluted income per share
|
|
|
14,556
|
|
|
|
14,720
|
|
|
|
14,581
|
|
|
|
14,720
|
|
See notes
to consolidated financial statements
ZONES, INC.
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY
(in
thousands, except share data)
(unaudited)
|
|
Common
Stock
|
|
|
Accumulated
Other Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
January 1, 2008
|
|
|
13,133,114
|
|
|
$
|
35,676
|
|
|
$
|
-
|
|
|
$
|
26,632
|
|
|
$
|
62,308
|
|
Purchase
and retirement of common stock
|
|
|
(47,600
|
)
|
|
|
(455
|
)
|
|
|
|
|
|
|
|
|
|
|
(455
|
)
|
Common
stock issued
|
|
|
140,858
|
|
|
|
73
|
|
|
|
|
|
|
|
|
|
|
|
73
|
|
Excess
tax benefit from stock options exercised
|
|
|
|
|
|
|
135
|
|
|
|
|
|
|
|
|
|
|
|
135
|
|
Stock-based
compensation expense
|
|
|
|
|
|
|
200
|
|
|
|
|
|
|
|
|
|
|
|
200
|
|
Subtotal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62,261
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,205
|
|
|
|
6,205
|
|
Foreign
currency translation adjustments
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
|
|
|
|
|
|
(3
|
)
|
Comprehensive
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,202
|
|
Balance,
June 30, 2008
|
|
|
13,226,372
|
|
|
$
|
35,629
|
|
|
$
|
(3
|
)
|
|
$
|
32,837
|
|
|
$
|
68,463
|
|
See notes
to consolidated financial statements
ZONES, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
(unaudited)
|
|
Six
months ended
June 30,
|
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income
|
|
$
|
6,205
|
|
|
$
|
6,720
|
|
Adjustments
to reconcile net income to net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
811
|
|
|
|
913
|
|
Non-cash
stock based compensation
|
|
|
200
|
|
|
|
98
|
|
Excess
tax benefit from exercise of stock options
|
|
|
(135
|
)
|
|
|
(81
|
)
|
(Increase)
decrease in assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables,
net
|
|
|
10,290
|
|
|
|
(13,460
|
)
|
Inventories
|
|
|
1,007
|
|
|
|
(3,169
|
)
|
Prepaid
expenses and other assets
|
|
|
(82
|
)
|
|
|
(182
|
)
|
Accounts
payable
|
|
|
(57
|
)
|
|
|
(1,427
|
)
|
Accrued
liabilities and deferred rent
|
|
|
(950
|
)
|
|
|
(1,709
|
)
|
Income
taxes payable
|
|
|
(375
|
)
|
|
|
1,443
|
|
Net
cash provided by (used in) operating activities
|
|
|
16,914
|
|
|
|
(10,854
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
|
(714
|
)
|
|
|
(1,152
|
)
|
Net
cash used in investing activities
|
|
|
(714
|
)
|
|
|
(1,152
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Net
change in book overdraft
|
|
|
(3,760
|
)
|
|
|
(2,167
|
)
|
Net
change in line of credit
|
|
|
|
|
|
|
4,900
|
|
Net
change in inventory financing
|
|
|
(7,083
|
)
|
|
|
4,068
|
|
Excess
tax benefit from exercise of stock options
|
|
|
135
|
|
|
|
81
|
|
Purchase
and retirement of common stock
|
|
|
(455
|
)
|
|
|
(552
|
)
|
Cancellation
of common stock
|
|
|
(54
|
)
|
|
|
|
|
Proceeds
from exercise of stock options
|
|
|
127
|
|
|
|
86
|
|
Net
cash provided by (used in) financing activities
|
|
|
(11,090
|
)
|
|
|
6,416
|
|
Effect
of foreign currency on cash flow
|
|
|
(3
|
)
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
5,107
|
|
|
|
(5,590
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
12,004
|
|
|
|
9,191
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
17,111
|
|
|
$
|
3,601
|
|
See notes
to consolidated financial statements
ZONES, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Description
of Business
Zones,
Inc. (the “Company,” “We”) is a single-source direct marketing reseller of
name-brand information technology products to the small-to-medium-sized business
market (“SMB”), large enterprise accounts and public sector
accounts. We sell these products through outbound and inbound account
executives, a national field sales force, catalogs and the
Internet. We offer more than 150,000 products from leading
manufacturers, including Adobe, Apple, Avaya, Cisco, Epson, HP, IBM, Kingston,
Lenovo, Microsoft, NEC, Nortel Networks, Sony, Symantec and
Toshiba.
On July
30, 2008, we entered into an Agreement and Plan of Merger (the “Merger
Agreement”) with Zones Acquisition Corp., a Washington corporation (“Acquisition
Co.”). Under the terms of the Merger Agreement, Acquisition Co. will be merged
with and into the Company, with the Company continuing as the surviving
corporation (the “Merger”). Acquisition Co. is owned by our Chairman and Chief
Executive Officer, Firoz Lalji.
At the
effective time of the Merger, each issued and outstanding share of common stock
of the Company (the “Common Stock”), other than any shares owned by Mr. Lalji
and certain related parties who will remain shareholders of the Company
(collectively, the “Continuing Investors”), by Acquisition Co., by the Company,
and by any shareholders who are entitled to and who properly exercise
dissenters’ rights under Washington law, will be converted into the right to
receive $8.65 in cash, without interest.
Our Board
of Directors approved the Merger Agreement on the unanimous recommendation of a
Special Committee composed solely of independent directors (the “Special
Committee”).
We have
made customary representations, warranties and covenants in the Merger
Agreement, which expire at the effective time of the Merger. The Merger
Agreement permits us to solicit superior proposals from third parties until
September 3, 2008, subject to an extension to September 17, 2008 in the
discretion of the independent members of the Board of Directors. In
addition, we may, at any time, subject to the terms of the Merger Agreement,
respond to unsolicited proposals. There can be no assurance that this
process will result in an alternative transaction to be acquired by a third
party. We do not intend to disclose developments with respect to the
solicitation process unless and until our Board of Directors has made a
decision.
Acquisition
Co. has obtained conditional equity and debt financing commitments for the
transactions contemplated by the Merger Agreement, the aggregate proceeds of
which will be sufficient for Acquisition Co. to pay the aggregate merger
consideration and all related fees and expenses. Consummation of the Merger is
not subject to a financing condition, but is subject to various other
conditions, including approval of the Merger not only by a majority of our
shareholders generally but also by shareholders holding a majority of shares
present in person or by proxy and voting at the shareholders’ meeting other than
Mr. Lalji and the other Continuing Investors, and other customary closing
conditions. The parties expect to close the transaction in the fourth quarter of
2008.
The
Merger Agreement may be terminated under certain circumstances, including if our
Board of Directors (or the Special Committee) has determined in good faith that
it has received a superior proposal and otherwise complies with certain terms of
the Merger Agreement. Upon the termination of the Merger Agreement, under
specified circumstances, we will be required to pay Acquisition Co. a
termination fee of $750,000. Additionally, under specified circumstances,
Acquisition Co. will be required to pay us a termination fee of $750,000. Mr.
Lalji has agreed to guarantee any such amounts payable by Acquisition Co. to
us.
This
description of the Merger Agreement is only a summary, does not purport to be
complete and is qualified in its entirety by reference to the Merger Agreement,
which was attached as Exhibit 2.1 to our Current Report on Form 8-K as filed on
July 31, 2008, and is incorporated herein by reference.
2. Summary
of Significant Accounting Policies
The
accompanying unaudited consolidated financial statements and notes have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission and consequently do not include all of the disclosures
normally required by generally accepted accounting principles.
Basis
of Presentation
In the
opinion of management, the accompanying unaudited consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
which in the opinion of management are necessary for a fair statement of the
financial position and operating results for the interim periods
presented. The results of operations for such interim periods are not
necessarily indicative of results for the full year. These financial
statements should be read in conjunction with the audited financial statements
and notes thereto contained in our Annual Report on Form 10-K for the year ended
December 31, 2007 as filed with the Securities and Exchange Commission on March
3, 2008.
Summary
of significant accounting policies
The
significant accounting policies used in the preparation of our financial
statements are disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2007.
Goodwill
In
accordance with SFAS No. 142,"Goodwill and Other Intangible Assets," goodwill is
tested for impairment annually on the purchase date or sooner when events
indicate that a potential impairment exists. We perform the
assessment annually on March 31, and all goodwill relates to the purchase of
Corporate PC Source, Inc. There were no changes to the carrying
amount of goodwill for the periods ended June 30, 2008 and December 31,
2007.
Revenue
Recognition
We adhere
to the revised guidelines and principles of sales recognition in Staff
Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition,” issued by the
staff of the SEC as a revision to Staff Accounting Bulletin No. 101, “Revenue
Recognition.” We recognize revenue on product sales when persuasive
evidence of an arrangement exists, delivery has occurred, prices are fixed or
determinable, and ability to collect is probable. We consider the
point of delivery of the product to be when the risks and rewards of ownership
have transferred to the customer. Our shipping terms dictate that the
passage of title occurs upon receipt of products by the customer except for the
last seven calendar days of each fiscal quarter, when all shipments are insured
in the name of the customer. For these seven days, passage of risk of loss and
title occur at the shipping point.
The
majority of our sales relate to physical products. For all product sales,
shipped directly from our warehouse or from our suppliers to customers, we are
the primary obligor, have full latitude in establishing price with the customer,
select the supplier to provide the product, take title to the product sold upon
shipment, bear credit risk, and bear inventory risk for returned
products. These sales are recognized on a gross basis with the
selling price to the customer recorded as sales and the acquisition cost of the
product recorded as cost of sales. Additionally, amounts billed for
shipping and handling are recorded as sales.
For all
third-party services, we are the primary obligor to our customer, we have full
latitude in establishing price with the customer, we select the third-party
service provider, we are obligated to compensate the service provider for work
performed regardless of whether the customer accepts the work and we bear credit
risk; therefore, these revenues are recognized on a gross basis with the selling
price to the customer recorded as sales and the acquisition cost of the service
recorded as cost of sales.
Software
maintenance contracts, software agency fees, and extended warranties that we
sell (for which we are not the primary obligor), are recognized on a net basis
in accordance with Emerging Issues Task Force Issue No. 99-19 (“EITF 99-19”),
“Reporting Revenue Gross as a Principal versus Net as an Agent.” We
do not take title to the products or assume any maintenance or return
obligations in these transactions; title is passed directly from the supplier to
our customer. Accordingly, such revenues are recognized in 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.
Sales are
reported net of sales, use or other transaction taxes that are collected from
the customers and remitted to taxing authorities. Sales are reported
net of returns and allowances. We offer limited return rights on our
product sales. We make what we believe to be reasonable estimates of
product returns based on significant historical experience. We had allowances
for sales returns of $74,000 and $76,000 at June 30, 2008 and December 31, 2007,
respectively.
Stock
Based Compensation
We
maintain equity incentive plans under which we may grant non-qualified stock
options, incentive stock options, restricted stock, restricted stock units
(“RSU”) or stock appreciation rights to team members and non-employee directors.
We issue new shares of common stock upon exercise of stock options, grant of
restricted stock and the vesting of RSUs.
Each
stock option granted has an exercise price of 100% of the market value of the
common stock on the date of the grant. The options generally have a contractual
life of 10 years and vest and become exercisable in 20% increments over five
years. As of June 30, 2008, there was $43,000 of total unrecognized
pre-tax compensation expense related to non-vested stock options granted under
our equity incentive plans. This cost is expected to be recognized over a
weighted-average period of 1.03 years. There were no stock options
granted in the six months ended June 30, 2008 or 2007. Although we do
not currently plan to grant additional stock options in 2008, we granted 75,000
shares of performance based restricted stock to certain team members during the
second quarter of 2008. As of June 30, 2008, there was $465,000 of
total unrecognized pre-tax compensation expense related to non-vested
performance-based restricted stock granted under our equity incentive plans.
Subject to achieving the specified performance milestones, this cost is expected
to be recognized over a weighted-average period of 2.00 years.
Earnings
Per Share
Earnings
per share (“EPS”) is based on the weighted average number of shares outstanding
during the period. Basic EPS excludes all dilution. Diluted EPS
reflects the potential dilution that would occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. We exclude all options to purchase common stock from the
calculation of diluted net income per share if such securities are
antidilutive.
Recent
Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
157”), which defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles and expands disclosures about
fair value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. SFAS 157 is effective for our fiscal year 2008. In February
2008, the FASB issued Staff Position No. 157-2, which provides a one-year
delayed application of SFAS 157 for nonfinancial assets and liabilities, except
for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually). Early adoption is
permitted. The adoption of SFAS 157 did not have a significant effect on our
financial statements.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”). Under SFAS 159,
entities may elect to measure specified financial instruments and warranty and
insurance contracts at fair value on a contract-by-contract basis, with changes
in fair value recognized in earnings each reporting period. The election, called
the fair value option, will enable entities to achieve an offset accounting
effect for changes in fair value of certain related assets and liabilities
without having to apply complex hedge accounting provisions. SFAS 159 is
effective as of the beginning of a company’s first fiscal year that begins after
November 15, 2007. Early adoption is permitted. The adoption of SFAS 159 did not
have a significant effect on our financial statements.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS 141R”), which replaces SFAS No. 141. SFAS 141R establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any resulting goodwill, and any noncontrolling interest in the acquiree. SFAS
141R also provides for disclosures to enable users of the financial statements
to evaluate the nature and financial effects of the business combination. SFAS
141R is effective for financial statements issued for fiscal years beginning
after December 15, 2008 and must be applied prospectively to business
combinations completed on or after that date. We will evaluate how the new
requirements could impact the accounting for any acquisitions completed
beginning in fiscal 2009 and beyond, and the potential impact on our
consolidated financial statements.
3. Earnings
Per Share
We have
45,000,000 common shares authorized. We have granted options to
purchase common shares or restricted stock to certain team members and our
non-employee directors. The following is a reconciliation of the
numerators and denominators of the basic and diluted earnings per share
computations (in thousands, except per share data).
|
|
Three
months ended June 30,
|
|
|
Six
months ended June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
3,626
|
|
|
$
|
4,409
|
|
|
$
|
6,204
|
|
|
$
|
6,720
|
|
Weighted
average shares outstanding
|
|
|
13,186
|
|
|
|
13,127
|
|
|
|
13,171
|
|
|
|
13,132
|
|
Basic
income per share
|
|
$
|
0.27
|
|
|
$
|
0.34
|
|
|
$
|
0.47
|
|
|
$
|
0.51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
3,626
|
|
|
$
|
4,409
|
|
|
$
|
6,204
|
|
|
$
|
6,720
|
|
Weighted
average shares outstanding
|
|
|
13,186
|
|
|
|
13,127
|
|
|
|
13,171
|
|
|
|
13,132
|
|
Stock
options
|
|
|
1,370
|
|
|
|
1,593
|
|
|
|
1,410
|
|
|
|
1,588
|
|
Total
common shares and dilutive securities
|
|
|
14,556
|
|
|
|
14,720
|
|
|
|
14,581
|
|
|
|
14,720
|
|
Diluted
income per share
|
|
$
|
0.25
|
|
|
$
|
0.30
|
|
|
$
|
0.43
|
|
|
$
|
0.46
|
|
For the
three and six months ended June 30, 2008 and 2007, 77,768 shares attributable to
outstanding stock options were excluded from the calculation of diluted earnings
per share because the effect was anti-dilutive. For the three and six
months ended June 30, 2008, 56,250 shares attributable to outstanding
performance based restricted stock grants were excluded from the calculation of
diluted earnings per share based on assumptions determining the probability of
the performance criterion.
4. Comprehensive
Income
Our total
comprehensive income was as follows for the periods presented (in
thousands):
|
|
Three
months ended
|
|
|
Six
months ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
3,626
|
|
|
$
|
4,409
|
|
|
$
|
6,204
|
|
|
$
|
6,720
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency adjustments
|
|
|
(3
|
)
|
|
|
|
|
|
|
(3
|
)
|
|
|
|
|
Total
comprehensive income
|
|
$
|
3,623
|
|
|
$
|
4,409
|
|
|
$
|
6,201
|
|
|
$
|
6,720
|
|
5. Commitments
and Contingencies
Legal
Proceedings
From time
to time, we are a party to various legal proceedings, claims, disputes or
litigation arising in the ordinary course of business. We currently
believe that the ultimate outcome of any of these proceedings, individually or
in the aggregate, will not have a material adverse effect on our business,
financial condition, cash flows or results of operations.
Related
Party
In June
2004, Fana Auburn LLC, a company owned by one of our officers, who is a majority
shareholder and a member of our board of directors, purchased the property and
buildings in which our headquarters are located, subject to the existing 11-year
lease. Under the terms of the lease agreement, we are obligated to
pay lease payments aggregating from $1.0 million to $1.3 million per year, plus
apportioned real estate taxes, insurance and common area maintenance charges.
Our Audit Committee reviewed and approved this related party transaction, and
also the potential corporate opportunity, recognizing that in the future we may
have to renew and renegotiate our lease and that such renewal and renegotiation
would also present a related party transaction, which would be subject to
further Audit Committee review and consideration. In May 2006, after
further review and approval by our Audit Committee, we signed an amendment to
the lease agreement increasing the rentable square feet by approximately 18,923
square feet. The additional square feet increased our annual lease
payment by $259,000. Effective January 1, 2007, we have approximately 125,196
rentable square feet located at 1102 15
th
Street
SW, Auburn, WA. In April 2007, we received a tenant improvement
reimbursement from Fana Auburn LLC in the amount of $378,000 related to
construction on the additional leased space, which will be amortized over the
remaining life of the lease. For the three months ended June 30, 2008
and 2007 we paid Fana Auburn LLC $541,000 and $549,000, respectively, related to
the lease, which is recorded in selling, general and administrative expenses.
For the six months ended June 30, 2008 and 2007 we paid Fana Auburn LLC $1.1
million related to the lease, which is recorded in selling, general and
administrative expenses.
6. Segment
Information
Our
business comprises one reportable segment: a single-source, multi-vendor direct
marketing reseller of name brand information technology products to
small-to-medium-sized businesses, large enterprise accounts and the public
sector markets.
A summary
of our sales by product mix follows (in thousands):
|
|
Three
months ended
June 30,
|
|
|
Six
months ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notebooks
& PDA’s
|
|
$
|
32,444
|
|
|
$
|
30,134
|
|
|
$
|
78,771
|
|
|
$
|
50,056
|
|
Desktops
& Servers
|
|
|
28,954
|
|
|
|
48,155
|
|
|
|
54,793
|
|
|
|
80,840
|
|
Software
|
|
|
30,445
|
|
|
|
30,446
|
|
|
|
56,274
|
|
|
|
54,773
|
|
Storage
|
|
|
10,264
|
|
|
|
13,234
|
|
|
|
22,410
|
|
|
|
24,942
|
|
NetComm
|
|
|
7,874
|
|
|
|
8,494
|
|
|
|
15,846
|
|
|
|
16,966
|
|
Printers
|
|
|
12,140
|
|
|
|
14,763
|
|
|
|
23,441
|
|
|
|
27,786
|
|
Monitors
& Video
|
|
|
12,369
|
|
|
|
17,372
|
|
|
|
25,245
|
|
|
|
31,859
|
|
Memory
& Processors
|
|
|
4,445
|
|
|
|
8,762
|
|
|
|
9,316
|
|
|
|
16,674
|
|
Accessories
& Other
|
|
|
19,398
|
|
|
|
20,872
|
|
|
|
38,993
|
|
|
|
36,518
|
|
Substantially
all of our net sales for the three and six months ended June 30, 2008 and 2007
were made to customers located in the United States. Substantially
all of our assets at June 30, 2008 and December 31, 2007 were located within the
United States. The amount of service revenue included in net sales
for the three and six months ended June 30, 2008 was $3.5 million and $5.6
million, respectively, and represented 2.2% and 1.7% of net sales,
respectively. For the three and six months ended June 30, 2007,
service revenue included in net sales was $2.5 million and $3.7 million,
respectively, representing 1.3% and 1.1% of net sales,
respectively. For the three months ended June 30, 2007, and the six
months ended June 30, 2008 and 2007, we had one customer that individually
represented more than 10% of total net sales. Net sales to this
customer declined 63.4% in the second quarter of 2008 from $37.2 million for the
three months ended June 30, 2007. Net sales to this customer were
$39.3 million and $52.8 million for the six months ended June 30, 2008 and 2007,
respectively. Trade receivables for this customer represented
approximately 11.6% and 5.7% of total trade receivables at June 30, 2008 and
2007, respectively.
7. Share
Repurchase Program
Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our Board
of Directors. Share repurchases may be made from time to time in both
open market and private transactions, as conditions warrant, at then prevailing
market prices. As of June 30, 2008, $2.5 million remained available for
repurchase of shares of our common stock under the program. The
current repurchase program is expected to remain in effect through February
2009, unless earlier terminated by the Board or completed.
8. Subsequent
Events
On July
30, 2008, we entered into a Merger Agreement pursuant to which Acquisition Co.,
which is owned by our Chairman and Chief Executive Officer, Firoz H. Lalji, will
merge with and into Zones in a going private transaction. Following the Merger,
Mr. Lalji and the Continuing Investors will own all of the outstanding shares of
the surviving corporation, and shares of Common Stock held by all other
shareholders will be converted into the right to receive $8.65 per share. The
transaction is subject to approval by a majority of our shareholders, as well as
by shareholders holding a majority of shares present in person or by proxy and
voting at the shareholders’ meeting other than Mr. Lalji and certain related
parties who will remain shareholders of the Company, and other customary closing
conditions. Assuming satisfaction or waiver of the conditions, the transaction
is expected to close during the fourth quarter of 2008. The Merger
Agreement is attached as Exhibit 2.1 to our Current Report on Form 8-K as filed
on July 31, 2008.
Item 2.
Management’s Discussion and
Analysis of Financial Condition and Results of
Operations
This
section contains forward-looking statements based on management’s current
expectations, estimates and projections about the industry, management’s
beliefs, and certain assumptions made by management. These statements are made
pursuant to the safe harbor provision of the Private Securities Litigation
Reform Act of 1995.
All
statements, trends, analyses and other information contained in this report
relative to trends in net sales, gross margin and anticipated expense levels, as
well as other statements, including words such as “anticipate,” “believe,”
“plan,” “expect,” “estimate,” “intend” and other similar expressions, constitute
forward-looking statements. These forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those anticipated
or expressed in such statements. Potential risks and uncertainties
that may cause actual results to differ materially from those expressed or
implied include, among others, those set forth in Item 1A of this document and
those contained in our Annual Report on Form 10-K for the year ended December
31, 2007 as filed with the Securities and Exchange Commission on March 3,
2008. Except as required by law, we undertake no obligation to update
any forward-looking statement, whether as a result of new information, future
events or otherwise.
The
following discussion and analysis should be read in conjunction with our
Consolidated Financial Statements and Notes included in this quarterly report on
Form 10-Q. As used in this quarterly report on Form 10-Q, unless the
context otherwise requires, the terms “the Company,” “we” and “Zones” refer to
Zones, Inc., a Washington corporation.
General
Our net
sales consist primarily of sales of computer hardware, software, peripherals and
accessories, as well as revenue associated with freight billed to our customers,
net of product returns. Gross profit consists of net sales less product and
freight costs. Selling, general and administrative (“SG&A”) expenses include
warehousing and distribution costs, selling salaries including commissions,
order processing, telephone and credit card fees, and other costs such as
administrative salaries, stock compensation expense, depreciation, rent and
general overhead expenses. Advertising expense is marketing costs associated
with vendor programs, net of vendor cooperative advertising expense
reimbursements allowable under EITF 02-16 “Accounting for Consideration Received
from a Vendor by a Customer (Including a Reseller of the Vendor’s
Products).” Other expense represents interest expense, net of
non-operating income.
Overview
We are a
direct marketing reseller of technology hardware, software and services. We
procure and fulfill IT solutions for the SMB market (between 50 and 1000
computer users), large and enterprise customers (greater than 1000 computer
users) and the public sector (education and state and local governments).
Relationships with SMB, large and enterprise customers, and public sector
institutions represented 99.4% and 99.1% of total net sales during the six
months ended June 30, 2008 and 2007, respectively. The remaining sales were from
inbound customers, primarily consumers and small office/home office accounts
purchasing mostly Mac platform products.
We reach
our customers through an integrated marketing and merchandising strategy
designed to attract and retain customers. This strategy involves a
relationship-based selling model executed through outbound account executives, a
national field sales force, customized Web stores for corporate customers
through ZonesConnect, a state-of-the-art Internet portal at www.zones.com,
dedicated e-marketing and direct marketing vehicles, and catalogs for
demand-response opportunities and corporate branding.
We
utilize our purchasing and inventory management capabilities to support our
primary business objective of providing name-brand products at competitive
prices. We offer our customers more than 150,000 hardware, software, peripheral
and accessory products and services from more than 2,000
manufacturers.
The
management team regularly reviews our performance using a variety of financial
and non-financial metrics, including, but not limited to, net sales, gross
margin, cooperative advertising reimbursements, advertising expenses, personnel
costs, productivity per team member, accounts receivables aging, inventory
aging, liquidity and cash resources. Management compares the
various metrics against goals and budgets and takes appropriate action to
enhance performance.
We are
dedicated to creating a learning community of empowered individuals to serve our
customers with integrity, commitment and passion. At June 30, 2008 we had 760
team members in our consolidated operations, 350 of whom were inbound and
outbound account executives. The majority of our team members work at our
corporate headquarters in Auburn, Washington.
We make
additional company information available free of charge on our website,
www.zones.com/IR.
Critical
Accounting Policies
In Item 7
(“Management’s Discussion and Analysis of Financial Condition and Results of
Operations”) of our Annual Report on Form 10-K for the year ended December 31,
2007, which was filed with the Securities and Exchange Commission on March 3,
2008, we included a discussion of the most significant accounting policies and
estimates used in the preparation of our financial statements. There has been no
material change in the policies and estimates used in the preparation of our
financial statements since the filing of our most recent annual
report.
Results
of Operations
The
following table presents our unaudited consolidated results of operations, as a
percentage of net sales, and selected operating data for the periods
indicated.
|
|
Three
months ended
June 30,
|
|
|
Six
months ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost
of sales
|
|
|
86.9
|
|
|
|
88.3
|
|
|
|
87.6
|
|
|
|
88.1
|
|
Gross
profit
|
|
|
13.1
|
|
|
|
11.7
|
|
|
|
12.4
|
|
|
|
11.9
|
|
Selling,
general and administrative expenses
|
|
|
8.4
|
|
|
|
6.7
|
|
|
|
8.4
|
|
|
|
7.5
|
|
Advertising
expenses, net
|
|
|
1.2
|
|
|
|
1.2
|
|
|
|
1.1
|
|
|
|
1.2
|
|
Income
from operations
|
|
|
3.5
|
|
|
|
3.8
|
|
|
|
2.9
|
|
|
|
3.3
|
|
Other
(income) expense, net
|
|
|
(0.1
|
)
|
|
|
0.1
|
|
|
|
(0.1
|
)
|
|
|
0.1
|
|
Income
before income taxes
|
|
|
3.6
|
|
|
|
3.7
|
|
|
|
3.0
|
|
|
|
3.2
|
|
Provision
for income taxes
|
|
|
1.4
|
|
|
|
1.4
|
|
|
|
1.1
|
|
|
|
1.2
|
|
Net
income
|
|
|
2.2
|
%
|
|
|
2.3
|
%
|
|
|
1.9
|
%
|
|
|
2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected
operating data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
force, end of period
|
|
|
350
|
|
|
|
324
|
|
|
|
350
|
|
|
|
324
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
mix (% of net sales):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notebooks
& PDA’s
|
|
|
20.5
|
%
|
|
|
15.7
|
%
|
|
|
24.2
|
%
|
|
|
14.7
|
%
|
Desktops
& Servers
|
|
|
18.3
|
|
|
|
25.1
|
|
|
|
16.9
|
|
|
|
23.7
|
|
Software
|
|
|
19.2
|
|
|
|
15.8
|
|
|
|
17.3
|
|
|
|
16.1
|
|
Storage
|
|
|
6.5
|
|
|
|
6.9
|
|
|
|
6.9
|
|
|
|
7.3
|
|
NetComm
|
|
|
5.0
|
|
|
|
4.4
|
|
|
|
4.9
|
|
|
|
5.0
|
|
Printers
|
|
|
7.7
|
|
|
|
7.7
|
|
|
|
7.2
|
|
|
|
8.2
|
|
Monitors
& Video
|
|
|
7.8
|
|
|
|
9.0
|
|
|
|
7.8
|
|
|
|
9.4
|
|
Memory
& Processors
|
|
|
2.8
|
|
|
|
4.6
|
|
|
|
2.9
|
|
|
|
4.9
|
|
Accessories
& Other
|
|
|
12.2
|
|
|
|
10.8
|
|
|
|
11.9
|
|
|
|
10.7
|
|
Comparison
of Three Month Periods Ended June 30, 2008 and 2007
Net
Sales.
Consolidated net sales for the quarter ended June
30, 2008 decreased 17.6% to $158.3 million compared with $192.2 million in the
second quarter of 2007. Consolidated outbound sales to commercial and
public sector accounts decreased 17.4% to $157.5 million in the second quarter
of 2008 from $190.7 million in the corresponding period of the prior
year. Sales to our SMB customers decreased 4.6% to $70.8 million for
the quarter ended June 30, 2008 from $74.2 million in the second quarter of
2007. The decrease in sales was a reflection of the economic
environment as businesses increased their sales cycle to further evaluate
investments in IT products. Sales to our large enterprise customers
are often defined by large non-recurring product roll-outs and specific
contractual obligations which have expiration dates. Sales to our
large enterprise customers decreased 25.1% to $80.9 million in the second
quarter of 2008 compared with $108.0 million in the second quarter of
2007. The change is primarily due to a decline in sales to a
significant customer. During the second quarter of 2008, sales to this customer
declined 63.4% from $37.2 million in the second quarter of 2007. We
did not expect the prior-year magnitude of sales to this customer to repeat in
the second quarter of 2008. Net sales to public sector customers
decreased to $5.8 million in the second quarter of 2008 from $8.5 million in the
second quarter of 2007. Inbound sales to consumer and small
office/home office customers declined 44.9% to $841,000, which represented 0.5%
of net sales.
Gross
Profit.
Consolidated gross profit decreased to $20.8 million
for the second quarter of 2008, compared with $22.4 million in the second
quarter of 2007. The decrease in gross profit dollars was primarily
related to our decreased sales volumes which negatively impacted funding from
our vendor programs compared to the prior year. Gross profit as a
percentage of net sales increased to 13.1% in the quarter ended June 30, 2008
compared with 11.7% in the corresponding period of the prior
year. The year-over-year increase is directly related to the
significant low margin sales to a single customer in the second quarter of 2007,
as well as a 55 basis point increase related to Microsoft Enterprise Agreements
received in the second quarter of 2008 compared with the prior
year. Gross profit margins will continue to vary, and may decline
from current levels, due to changes in vendor programs, product mix, pricing
strategies, customer mix,
the sale of
third-party services and other fee or commission based sales, and economic
conditions. Lastly, we categorize our warehousing and distribution
network costs in selling, general and administrative expenses. Due to
this classification, our gross profit may not be comparable to a company that
includes its warehousing and distribution network costs as a cost of
sales.
Selling, General and Administrative
Expenses.
SG&A expenses increased 4.2% to $13.3 million
for the quarter ended June 30, 2008, compared to $12.8 million in
2007. As a percentage of sales, SG&A increased to 8.4% for the
quarter ended June 30, 2008 from 6.7% in the second quarter of 2007, primarily
due to decreased sales volumes. The composition of our SG&A
expenses changed due to the following factors:
|
·
|
Salaries,
wages and benefits increased $446,000 during the second quarter of 2008
compared with the prior year. The increased expense was
primarily due to increased headcount, partially offset by a reduction in
variable compensation expense.
|
|
·
|
Professional
fees increased $100,000 for the quarter ended June 30, 2008 compared with
the quarter ended June 30, 2007, primarily due to increased legal fees
relating to our Board of Director’s evaluation of strategic
alternatives.
|
|
·
|
Credit
card fees increased by $88,000 in the second quarter of 2008 compared with
the second quarter of the prior year, primarily due to a one-time receipt
of a class action lawsuit settlement in the second quarter of 2007 in
connection with having been overcharged fees on processing debit card
payments in prior years.
|
|
·
|
Depreciation
expense has decreased by $75,000 for the quarter ended June 30, 2008
compared with the second quarter of 2007 primarily due to the aging of
fixed assets.
|
For the
periods ending June 30, 2008 and 2007, warehousing and distribution network
costs totaled $564,000 and $647,000, respectively.
Advertising Expenses,
net
. We produce and distribute direct mail collateral,
targeted campaign materials and catalogs at various intervals throughout the
year to increase awareness of our brand and stimulate demand
response. Our net cost of advertising decreased to $1.8 million in
the three month period ended June 30, 2008 from $2.2 million in the comparable
2007 period.
|
·
|
Gross
advertising expense decreased to $2.1 million for the second quarter of
2008 compared with $2.6 million in the second quarter of 2007, primarily
due to decreased expenses associated with catalog distribution and lead
management expense.
|
|
·
|
Gross
advertising vendor reimbursements decreased to $274,000 in the second
quarter of 2008 from $324,000 in the second quarter of 2007. We have
classified substantially all vendor consideration as a reduction of cost
of goods sold rather than as a reduction of advertising
expense.
|
Other Income/Expense,
net.
Other income was $139,000 for the quarter ended June 30,
2008 compared with $239,000 other expense in the quarter ended June 30,
2007. Interest expense related to our use of the working capital line
was $0 and $276,000 for the three month periods ended June 30, 2008 and 2007,
respectively. The interest income for the three months ended June 30,
2008 was $139,000, compared with $38,000 for the second quarter of
2007. Interest income represent amounts earned on short-term
investments and finance charges collected from certain customers, which vary
from period to period.
Provision for Income
Taxes.
The provision for income taxes for the quarter ended
June 30, 2008 was $2.2 million compared with $2.7 million in the comparable
period of the prior year. Our effective tax rate expressed as a
percentage of income before taxes was 37.3% for the quarter ended June 30, 2008
compared with 38.2% for the quarter ended June 30, 2007. The
effective tax rate is dependent upon our estimations regarding the level of
annual pre-tax income, state taxes, the magnitude of any nondeductible expenses
in relation to that pre-tax amount and various other factors.
Net Income.
Net
income for the quarter ended June 30, 2008 was $3.6 million compared with $4.4
million in the second quarter of 2007. Basic and diluted income per
share was $0.27 and $0.25, respectively, for the three months ended June 30,
2008, compared with $0.34 and $0.30, respectively, for the quarter ended June
30, 2007.
Comparison
of Six Month Periods Ended June 30, 2008 and 2007
Net
Sales.
Consolidated net sales for the six months ended June
30, 2008 decreased 4.5% to $325.1 million compared with $340.4 million in the
six months ended June 30, 2007. Consolidated outbound sales to
commercial and public sector accounts decreased 4.2% to $323.1 million in the
six months ended June 30, 2008 from $337.3 million in the corresponding period
of the prior year. Sales to our SMB customers increased 3.3% to
$142.7 million for the six months ended June 30, 2008 from $138.2 million in the
comparable period of 2007. Growth in our SMB sales was primarily due
to headcount increases in our Portland sales center. Headcount in our Portland
Sales center has increased to 108 sales account executives at June 30, 2008 from
87 sales account executives at June 30, 2007. Sales to our large
enterprise customers decreased 8.8% to $169.0 million in the first six months of
2008 compared with $185.4 million in the first six months of
2007. The change is primarily due to a decline in sales to a
significant customer. During the six months ended June 30, 2008, sales to this
customer declined 25.7% from $52.8 million in the six months ended June 30,
2007. We did not expect the magnitude of sales to this customer to
repeat in the first half of 2008. Net sales to public
sector customers decreased to $11.3 million in the first six months of 2008 from
$13.7 million in the first six months of 2007. Inbound sales to
consumer and small office home office customers declined 36.5% to $2.0 million,
which represented 0.6% of net sales.
Gross Profit.
Consolidated
gross profit decreased slightly to $40.4 million for the six months ended June
30, 2008, compared with $40.6 million in the first six months of
2007. Gross profit as a percentage of net sales increased to 12.4% in
the six months ended June 30, 2008 compared with 11.9% in the corresponding
period of the prior year. The increase is directly related to the
large low margin sales to a single customer in the second quarter of 2007, as
well as an increase in fees earned from Microsoft Enterprise
Agreements. Gross profit margins will continue to vary, and may
decline from current levels, due to changes in vendor programs, product mix,
pricing strategies, customer mix,
the sale of
third-party services and other fee or commission based sales, and economic
conditions. Lastly, we categorize our warehousing and distribution
network costs in selling, general and administrative expenses. Due to
this classification, our gross profit may not be comparable to a company that
includes its warehousing and distribution network expenses as a cost of
sales.
Selling, General and Administrative
Expenses.
SG&A expenses increased to $27.2 million for the
six months ended June 30, 2008 compared with $25.4 million in the comparable
period of 2007. As a percentage of sales, SG&A increased to 8.4%
for the six months ended June 30, 2008 from 7.5% in the six months ended June
30, 2007, primarily as a function of the decrease in sales
volumes. The increase in SG&A expenses was due to the following
factors:
|
·
|
Salaries,
wages and benefits increased $1.4 million during the first six month of
2008 compared with the same period of the prior year, primarily due the
increase in headcount. Our total headcount increased to 760
team members at June 30, 2008 compared to 669 at June 30,
2007. Our June 30, 2008 headcount includes 53 team members in
our Indian subsidiary.
|
|
·
|
Professional
fees increased $393,000 for the six months ended June 30, 2008 compared
with the six months ended June 30, 2007, primarily due to increased legal
fees in 2008 relating to our Board of Director’s evaluation of strategic
alternatives.
|
|
·
|
Bad
debt expense has increased $125,000 for the six months ended June 30, 2008
compared with the six months ended June 30, 2007, primarily due to the
adjustment of reserves for vendor
receivables.
|
|
·
|
Depreciation
expense has decreased $102,000 for the six months ended June 30, 2008
compared with the six months ended June 30, 2007, mostly attribute to the
aging of fixed assets.
|
For the
periods ending June 30, 2008 and 2007, warehousing and distribution network
costs remained flat at $1.2 million.
Advertising Expenses,
net
. We produce and distribute direct mail collateral,
targeted campaign materials and catalogs at various intervals throughout the
year to increase awareness of our brand and stimulate demand
response. Our net cost of advertising decreased to $3.6 million in
the six month period ended June 30, 2008 from $4.1 million in the comparable
period in 2007.
|
·
|
Gross
advertising expense decreased to $4.3 million for the first six months of
2008 compared with $4.9 million in the first six months of 2007, primarily
due to declines in our expenses associated with catalog distribution and
vendor-specific marketing
activities.
|
|
·
|
Gross
advertising vendor reimbursements decreased to $717,000 in the six months
ended June 30, 2008 from $777,000 in the six months ended June 30,
2007. As advertising programs with our vendor partners have
become more comprehensive, we have classified substantially all vendor
consideration as a reduction of cost of goods sold rather than a reduction
of advertising expense.
|
Other Income/Expense,
net.
Other income was $243,000 for the six months ended June
30, 2008 compared with other expense of $215,000 for the six months
ended June 30, 2007. Interest expense related to the use of our
working capital line was $2,000 and $307,000 for the six month periods ended
June 30, 2008 and 2007, respectively. The interest income was
$245,000 for the six months ended June 30, 2008 compared with $94,000 for the
six months ended June 30, 2007. Interest income represent amounts
earned on short-term investments and finance charges collected from certain
customers, which vary from period to period.
Provision for Income
Taxes.
The provision for income taxes for the six months ended
June 30, 2008 was $3.7 million compared with $4.2 million in the comparable
period of the prior year. Our effective tax rate expressed as a
percentage of income before taxes was 37.3% for the six months ended June 30,
2008 compared with 38.3% for the six months ended June 30, 2007. The
effective tax rate is dependent upon our estimations regarding the level of
annual pre-tax income, state taxes, the magnitude of any nondeductible expenses
in relation to that pre-tax amount and various other factors.
Net Income.
Net
income for the six months ended June 30, 2008 was $6.2 million compared with
$6.7 million in the first six months of 2007. Basic and diluted
income per share was $0.47 and $0.43, respectively, for the six months ended
June 30, 2008, compared with $0.51 and $0.46, respectively, for the six months
ended June 30, 2007.
Liquidity
and Capital Resources
Working
Capital.
Our total
assets were $127.1 million at June 30, 2008, of which $118.1 million were
current assets. At June 30, 2008 and December 31, 2007, we had cash
and cash equivalents of $17.1 million and $12.0 million, respectively, and had
working capital of $61.1 million and $55.0 million, respectively. The increase
in working capital was primarily a result of a decline in our accounts payable
and inventory financing balance, and collection of trade accounts receivable
which increased our on-hand cash and cash equivalents.
Stock
Repurchase Program.
Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our Board
of Directors. Share repurchases may be made from time to time in both
open market and private transactions, as conditions warrant, at then prevailing
market prices. As of June 30, 2008, $2.5 million remained available
for share repurchases under the program. The current repurchase program is
expected to remain in effect through February 2009, unless earlier terminated by
the Board or completed.
There was
no activity during the quarter ended June 30, 2008.
Approximately
94% of our sales are processed on open account terms offered to our customers,
and we typically experience significant sales during the last month of the
period on open account, which could cause fluctuation in our accounts receivable
balance. To finance these sales, we leverage our secured line of
credit to offset timing differences in cash inflows and cash outflows, to invest
in capital equipment purchases, to purchase inventory for general stock as well
as for identified customers, and to take full advantage of available early pay
discounts.
We have a
$50.0 million secured line of credit facility with a major financial
institution, which is collateralized by accounts receivable and inventory, and
it can be utilized as both a working capital line of credit and an inventory
financing facility to purchase products from several suppliers under certain
terms and conditions. This credit facility has an annual automatic
renewal which occurs on November 26 of each fiscal year. Either party can
terminate this agreement with 60 days written notice prior to the renewal
date. The working capital and inventory advances bear interest at a
rate of Prime plus 0.50%. Our line of credit is defined by quick
turnover, large amounts and short maturities. All amounts owed under the line of
credit are due on demand. Amounts owed under the inventory financing
facility do not bear interest if paid within terms, usually 30 days from invoice
date. The facility contains various restrictive covenants relating to
tangible net worth, leverage, dispositions and use of collateral, other asset
dispositions, and merger and consolidation. At June 30, 2008, there
were no outstanding working capital advances, and inventory financing
arrangements of $13.2 million were owed to this financial
institution. At June 30, 2008, we were in compliance with all
covenants of this facility.
We
believe that our existing available cash and cash equivalents, operating cash
flow, and existing credit facilities will be sufficient to satisfy our operating
cash needs, and to fund the remaining balance of $2.5 million authorized in our
stock repurchase program, for at least the next 12 months at our current level
of business. However, if our working capital or other capital
requirements are greater than currently anticipated, we could be required to
reduce or curtail our stock repurchase program and seek additional funds through
sales of equity, debt or convertible securities, or through increased credit
facilities. There can be no assurance that additional financing will
be available or that, if available, the financing will be on terms favorable to
us and our shareholders.
Cash
Flows
Net cash
provided by operating activities was $16.9 million in the six months ended June
30, 2008. The primary factors that affected cash flow from operating
activities during this period were account and vendor receivables and inventory
levels. Account and vendor receivables decreased $10.3 million due to
changes in sales volumes and collection efforts. Inventory decreased
$1.0 million. Included in inventory at June 30, 2008, was $5.3
million of inventories pursuant to customer contracts, which will be recorded as
net sales when the criteria for sales recognition are met.
Net cash
used in investing activities was $714,000 in the six months ended June 30,
2008. Cash outlays for capital expenditures were $714,000 for the six
months ended June 30, 2008. Capital expenditures were primarily
for leasehold improvements to our corporate headquarters, and continued
improvement and other enhancements of our information systems. We
intend to continue to upgrade our internal information systems as a means to
increase operational efficiencies.
The most
significant components of our financing activities are: the purchase
of common stock under our share repurchase program, net change in inventory
financing and net change in book overdraft. For the six month period
ended June 30, 2008, we repurchased $455,000 of our common stock under our share
repurchase program. Net change in our book overdraft for the six
month period ended June 30, 2008 was a decrease of $3.8
million. Inventory financing decreased $7.1 million due to
fluctuations in our purchasing and payment cycles.
Subsequent
Events
On July
30, 2008, we entered into a Merger Agreement pursuant to which Acquisition Co.,
which is owned by our Chairman and Chief Executive Officer, Firoz H. Lalji, will
merge with and into Zones in a going private transaction. Following the Merger,
Mr. Lalji and the Continuing Investors will own all of the outstanding shares of
the surviving corporation, and shares of Common Stock held by all other
shareholders will be converted into the right to receive $8.65 per share. The
transaction is subject to approval by a majority of our shareholders, as well as
by shareholders holding a majority of shares present in person or by proxy and
voting at the shareholders’ meeting other than Mr. Lalji and certain related
parties who will remain shareholders of the Company, and other customary closing
conditions. Assuming satisfaction or waiver of the conditions, the transaction
is expected to close during the fourth quarter of 2008. The Merger
Agreement is attached as Exhibit 2.1 to our Current Report on Form 8-K as filed
on July 31, 2008.
We might
find it necessary to terminate the Merger Agreement under certain specified
circumstances in order to enter into a definitive agreement implementing an
alternative acquisition proposal. If we so terminate the Merger Agreement, we
are required to pay Acquisition Co. a termination fee equal to $750,000, or
$300,000 if we terminate to enter into an agreement with respect to a superior
proposal received before the end of the “go-shop” period. In addition, if our
shareholders fail to approve the Merger, and under certain other specified
circumstances, we would be required to reimburse Acquisition Co. for certain of
its expenses, up to a maximum of $300,000, and regardless of whether the Merger
is consummated, we are required to pay fees for legal, financial, printing and
other services in connection with the Merger..
Item 3.
Quantitative and Qualitative
Disclosures About Market Risk
We are
subject to the risk of fluctuating interest rates in the normal course of
business, primarily as a result of our short-term borrowing and investment
activities, which generally bear interest at variable rates. Because
the short-term borrowings and investments have maturities of three months or
less, we believe that the risk of material loss is low.
Item 4.
Controls and
Procedures
Under the
supervision and with the participation of our management team, including our
Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of our disclosure controls and procedures, as such term is defined
in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of
1934, as amended. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this quarterly
report.
There has
been no change in our internal control over financial reporting during our most
recently completed fiscal quarter that materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
The
certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 are
filed as exhibits 31.1 and 31.2, respectively, to this Quarterly Report on Form
10-Q.
Part II.
Item 1.
Legal
Proceedings
From time
to time, we are party to various legal proceedings, claims, disputes or
litigation arising in the ordinary course of business. We currently
believe that the ultimate outcome of any of these proceedings, individually or
in the aggregate, will not have a material adverse effect on our business,
financial condition, cash flows or results of operations.
Item 1A.
Risk
Factors
There are
a number of important factors that could cause our actual results to differ
materially from historical results or those indicated by any forward-looking
statements, including the risk factors identified below and other factors of
which we may or may not yet be aware.
Failure to complete the going private
transaction would likely have an adverse effect on us.
On July
30, 2008, we entered into a Merger Agreement pursuant to which Acquisition Co.,
which is owned by our Chairman and Chief Executive Officer, Firoz H. Lalji, will
merge with and into Zones in a going private transaction. Following the Merger,
Mr. Lalji and the Continuing Investors will own all of the outstanding shares of
the surviving corporation, and shares of Common Stock held by all other
shareholders will be converted into the right to receive $8.65 per
share. There can be no assurance that the conditions to closing
specified in the Merger Agreement will be satisfied. In connection
with the going private transaction, we are subject to several risks, including
the following:
|
·
|
On
July 30, 2008, the last trading day prior to the announcement of
management’s proposal of the merger, our common stock closed at $5.44 per
share. After that announcement, the stock price rose to trade close to the
$8.65 per share proposal price. Since the merger agreement was signed, our
common stock has traded generally between $8.23 and $8.35 per share. The
current price of our common stock may reflect a market assumption that the
merger will close. If the merger is not consummated, the stock price would
likely retreat from its current trading
range.
|
|
·
|
Certain
costs relating to the merger, including legal, accounting and financial
advisory fees, are payable by us whether or not the merger is completed.
These costs will be substantial and may materially reduce our earnings per
share.
|
|
·
|
Under
circumstances set out in the Merger Agreement, if the going private
transaction is not completed, we may be required to pay the acquiring
company a termination fee of $750,000 and reimburse up to $300,000 of the
acquiring company’s expenses, which will be credited against the
termination fee if it becomes
payable.
|
|
·
|
Our
management’s and our team members’ attention will be diverted from our
day-to-day operations; we may experience team member attrition; and our
business, including our vendor and customer relationships, may be
disrupted during the period while the going private transaction remains
pending. These risks could increase if the transaction is not
consummated.
|
While the Merger Agreement is in
effect, we are subject to restrictions on our business
activities.
While the
Merger Agreement is in effect, we are subject to significant restrictions on our
business activities and must generally operate our business in the ordinary
course (subject to certain exceptions or the consent of the acquiring company).
These restrictions on our business activities could have a material adverse
effect on our future results of operations or financial condition.
Our
operating results are difficult to predict and may adversely affect our stock
price.
Our
operating results are difficult to forecast, and there are a number of factors
outside of our control, including:
|
·
|
purchasing
cycles of commercial and public sector
customers;
|
|
·
|
the
level of corporate investment in new IT-related capital
equipment;
|
|
·
|
more
manufacturers going direct;
|
|
·
|
industry
announcements of new products or
upgrades;
|
|
·
|
industry
consolidation and increased
competition;
|
|
·
|
cost
of compliance with new legal and regulatory
requirements;
|
|
·
|
general
economic conditions; and
|
|
·
|
variability
of vendor programs.
|
Based on
those and other risks, there can be no assurance that we will be able to
maintain the profitability we have experienced going forward.
We experience variability in our net
sales and net income on a quarterly basis.
There is
no assurance that we will sustain our current sales or income
levels. Sales and income may decline for any number of reasons,
including:
|
·
|
a
decline in corporate profits leading to a change in corporate investment
in IT-related equipment;
|
|
·
|
more
manufacturers going direct;
|
|
·
|
changes
in customers’ buying habits;
|
|
·
|
the
loss of significant customers;
|
|
·
|
changes
in the selection of products available for resale;
or
|
|
·
|
general
economic conditions.
|
A decline
in sales levels could adversely affect our business, financial condition, cash
flows or results of operations.
Our
narrow gross margins magnify the impact of variations in our operating
costs.
There is
intense price competition and pressure on profit margins in the computer
products industry. A number of manufacturers also provide their
products directly to customers. Various other factors also may create
downward pressure on our gross margins, such as the quarter-to-quarter
variability in vendor programs and an increasing proportion of sales to
enterprise, public sector or other competitive bid accounts on which margins
could be lower. If we are unable to maintain or improve gross margins
in the future, this could have an adverse effect on our business, financial
condition, or results of operations.
Our
increased investments in hiring, retaining and productivity of our sales force
may not improve our profitability or result in expanded market
share.
We ended
the second quarter of 2008 with 350 account executives. We expect to
continue to hire account executives, but at a lower rate of growth due to
corporate initiatives to lower turnover thus reducing hiring requirements in
2008. However, there are no assurances that we will be able to hire to our
expected levels, or recruit the quality individuals that we hope to hire, or
that the individuals hired will remain employed for an extended period of time,
or that we will not lose existing account executives. The
productivity of account executives has historically been closely correlated with
tenure. Even if we do retain our account executives, there are no
assurances that they will become productive at historical
levels. Additionally, there are no assurances that the locations of
our call centers will continue to attract qualified account executives, or that
we will be able to remotely manage and retain the new account
executives.
Certain of our key vendors provide us
with incentives and other assistance, and any future decline in these incentives
and other assistance could materially harm our profit margins and operating
results.
We have a
variety of relationships with our vendors that in the past have contributed
significantly to profit margins. For example, certain product
manufacturers and distributors provide us with incentives in the form of
rebates, volume incentive rebates, cash discounts and trade
allowances. Our vendors continue to redefine current programs and
there are no assurances that we will attain the level of vendor support in the
future that we have obtained in the past. In addition, many of our
vendors provide us with cooperative advertising funds, which reimburse us for
expenses associated with specific forms of
advertising. Industry-wide, the trend has been for manufacturers,
distributors and vendors to reduce these incentives and programs. We
believe that the 2008 incentives may decline as a percentage of sales compared
with historical amounts due to changes in available programs and
targets. If these forms of vendor support significantly decline, or
if we are otherwise unable to take advantage of continuing vendor support
programs, or if we fail to manage the complexity of these programs, our
business, financial condition, cash flows or results of operations could be
adversely affected.
We
are controlled by a principal stockholder.
Firoz H.
Lalji, our Chairman and Chief Executive Officer, beneficially owns approximately
51% of the outstanding shares of Zones common stock, excluding shares that he
may acquire upon exercise of stock options that he holds. The voting
power of these shares enables Mr. Lalji to significantly influence our affairs
and the vote on corporate matters to be decided by our shareholders, including
the outcome of elections of directors. This effective voting control
may preclude other shareholders from being able to influence shareholder votes
and could block changes to our articles of incorporation or bylaws, which could
adversely affect the trading price of our common stock.
On July
30, 2008, we entered into a Merger Agreement pursuant to which Acquisition Co.,
which is owned by our Chairman and Chief Executive Officer, Firoz H. Lalji, will
merge with and into Zones in a going private transaction, and the shares of
Common Stock held by shareholders other than Mr. Lalji and the Continuing
Investors will be converted into the right to receive $8.65 per share. Although
the Merger Agreement contains a “go-shop” provision that permits us to solicit
superior proposals during a limited time period and to terminate the Merger
Agreement and enter into an alternative transaction to be acquired by a third
party, any alternative transaction would be subject to the approval of Mr. Lalji
as our majority shareholder. In addition, Mr. Lalji’s effective voting control
and matching rights contained in the Merger Agreement may discourage other
bidders from making a superior proposal.
We
may lose potential revenue and competitive advantage if we lose our
certification as a Minority Business Enterprise.
We are
certified as a Minority Business Enterprise (“MBE”) based on Mr. Lalji’s
maintenance of voting control of our outstanding common stock. A
decrease in Mr. Lalji’s level of voting power through the issuance of additional
equity capital or through a business combination transaction could cause us to
lose our MBE certification. Our MBE certification allows us to
compete for certain sales opportunities for which we otherwise may not be able
to compete and gives us an advantage in other sales
opportunities. Although we are unable to quantify the portion of our
revenue that we receive or retain primarily as a result of our MBE
certification, we believe a loss of our MBE certification would cause us to lose
potential revenue and competitive advantage in certain sales opportunities and
could have an adverse affect on our ability to retain certain customers and
compete for certain sales opportunities, as well as on our financial
performance.
We
may not be able to compete successfully against existing or future competitors,
which include some of our largest vendors.
The
computer products industry is highly competitive. We compete with other national
direct marketers, including CDW Corporation, Insight Enterprises, Inc. and PC
Connection, Inc. We also compete with product manufacturers, such as Apple,
Dell, Hewlett-Packard, IBM and Lenovo, which sell directly to end-users, in
addition to competing with specialty computer retailers, computer and general
merchandise superstores, and consumer electronic and office supply
stores. Many of our competitors compete principally on the basis of
price and have lower costs. We believe that competition may intensify
in the future due to market conditions and consolidation. In the
future, we may face fewer, but larger or better-financed
competitors. Additional competition may also arise if other methods
of distribution emerge in the future. There can be no assurance that we will be
able to compete effectively with existing competitors or new competitors that
may enter the market, or that our business, financial condition, cash flows or
results of operations will not be adversely affected by intensified
competition.
We
are exposed to inventory obsolescence due to the rapid technological changes
occurring in the personal computer industry.
The
computer industry is characterized by rapid technological change and frequent
introductions of new products and product enhancements. To satisfy
customer demand and obtain greater purchase discounts, we may be required to
carry significant inventory levels of certain products, which would subject us
to increased risk of inventory obsolescence. We participate in first-to-market
and end-of-lifecycle purchase opportunities, both of which carry the risk of
inventory obsolescence. Special purchase products are sometimes acquired without
return privileges, and there can be no assurance that we will be able to avoid
losses related to such products. Within the industry, vendors are
becoming increasingly restrictive in guaranteeing return
privileges. While we seek to reduce our inventory exposure through a
variety of inventory control procedures and policies, there can be no assurance
that we will be able to avoid losses related to obsolete inventory.
We
may not be able to maintain existing or build new vendor relationships, which
may affect our ability to offer a broad selection of products at competitive
prices and negatively impact our results of operations.
We
acquire products directly from manufacturers, such as Apple, Hewlett-Packard,
IBM and Lenovo, as well as from distributors such as Ingram Micro, Synnex, Tech
Data and others. Certain hardware manufacturers limit the number of
product units available to DMRs. Substantially all of our contracts
and arrangements with vendors are terminable without notice or upon short
notice. If we do not maintain our existing relationships or build new
relationships with vendors on acceptable terms, including favorable product
pricing and vendor consideration, we may not be able to offer a broad selection
of products or continue to offer products at competitive prices. Termination,
interruption or contraction of our relationships with our vendors could have a
material adverse effect on our business, financial condition, cash flows or
results of operations.
If
we fail to achieve and maintain adequate internal controls, we may not be able
to produce reliable financial reports in a timely manner or prevent financial
fraud.
We will
continue to document and test our internal control procedures on an ongoing
basis in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002, which requires annual management assessments of the effectiveness
of internal controls over financial reporting and a report by an independent
registered public accounting firm addressing such assessments if applicable.
During the course of our testing we may from time to time identify deficiencies
which we may not be able to remediate. In addition, if we fail to achieve or
maintain the adequacy of our internal controls, as such standards are modified,
supplemented or amended from time to time, we may not be able to ensure that we
can conclude on an ongoing basis that we have effective internal controls over
financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of
2002. Effective internal controls, particularly those related to revenue
recognition, are necessary for us to produce reliable financial reports and are
important in helping prevent financial fraud. If we cannot provide reliable
financial reports on a timely basis or prevent financial fraud, our business and
operating results could be harmed, investors could lose confidence in our
reported financial information, and the trading price of our stock could drop
significantly.
We
face many uncertainties relating to the collection of state sales and use
tax.
We
collect and remit sales and use taxes in states in which we have voluntarily
registered and/or have a physical presence. Various states have sought to
require the collection of state and local sales taxes on products shipped to the
taxing jurisdiction’s residents by DMRs. The United States Supreme
Court held in 1992 that it is unconstitutional for a state to impose sales or
use tax collection obligations on an out-of-state company whose contacts with
the state were limited to the distribution of catalogs and other advertising
materials through the mail and the subsequent delivery of purchased goods by
United States mail or by common carrier. We cannot predict the level of contact,
including electronic commerce and Internet activity, which might give rise to
future or past tax collection obligations based on that Supreme Court
case. Many states aggressively pursue out-of-state businesses, and
legislation that would expand the ability of states to impose sales tax
collection obligations on out-of-state businesses has been introduced in
Congress on many occasions. A change in the law could require us to collect
sales taxes or similar taxes on sales in states in which we have no presence and
could potentially subject us to a liability for prior year sales, either of
which could have a material adverse effect on our business, financial condition,
and results of operations.
We
rely on our distribution centers and certain distributors to meet the product
needs of our customers.
We
operate warehouse and distribution centers in Bensenville, Illinois and in
Seattle, Washington. There are no assurances that our warehouse
locations will best support our customer base. Additionally, certain
distributors participate in our logistics operations through electronic data
interchange. Failure to develop and maintain relationships with these
and other vendors would limit our ability to obtain sufficient quantities of
merchandise on acceptable commercial terms and could have a material adverse
effect on our business, financial condition, cash flows or results of
operations.
We
are heavily dependent on commercial delivery services.
We
generally ship our products to customers by DHL, Eagle, FedEx, United Parcel
Service and other commercial delivery services and invoice customers for
delivery charges. If we are unable to pass on to our customers future increases
in the cost of commercial delivery services, our profitability could be
adversely affected. Additionally, strikes or other service interruptions by such
shippers could adversely affect our ability to deliver products on a timely
basis.
We
may not be able to attract and retain key personnel.
Our
future success will depend to a significant extent upon our ability to attract,
train and retain skilled personnel. Although our success will depend
on personnel in all areas of our business, there are certain individuals that
play key roles within the organization. Loss of any of these
individuals could have an adverse effect on our business, financial condition,
cash flows or results of operations.
We
may be impacted by the loss of a major customer.
From time
to time we have customers that represent more than 10% of total sales. For the
three months ended June 30, 2007, and the six months ended June 30, 2008 and
2007, State Farm Group individually represented more than 10% of total net
sales. Net sales to this customer declined 63.4% during the second
quarter of 2008 from $37.2 million in the second quarter of 2007. Net
sales to this customer were $39.3million and $52.8 million for the six months
ended June 30, 2008 and 2007, respectively. Trade receivables for
this customer represented approximately 11.6% and 5.7% of total trade
receivables at June 30, 2008 and 2007, respectively. The loss of
business with any major customer could have a material adverse effect on our
business, financial condition, cash flows or results of operations.
Our
systems are vulnerable to natural disasters or other catastrophic
events.
Our
operations are dependent on the reliability of information, telecommunication
and other systems, which are used for sales, distribution, marketing,
purchasing, inventory management, order processing, customer service and general
accounting functions. Interruption of our information systems,
Internet or telecommunication systems could have a material adverse effect on
our business, financial condition, cash flows or results of
operations.
Privacy
concerns with respect to list development and maintenance may materially
adversely affect our business.
If third
parties or our team members are able to penetrate our network security or
otherwise misappropriate our customers’ personal information or credit card
information, we could be subject to liability. We also mail catalogs
and send electronic messages to names in our proprietary customer database and
to potential customers whose names we obtain from rented or exchanged mailing
lists. World-wide public concern regarding personal privacy has subjected the
rental and use of customer mailing lists and other customer information to
increased scrutiny. Any domestic or foreign legislation enacted limiting or
prohibiting these practices could negatively affect our business.
Our
stock price may be volatile.
There is
relatively limited trading of our stock in the public markets, and this may
impose significant practical limitations on any shareholder’s ability to achieve
liquidity at any particular quoted price. Efforts to sell significant
amounts of our stock on the open market may precipitate significant declines in
the prices quoted by market makers. The limitation on shareholder
liquidity resulting from this relatively thin trading volume could be
exacerbated if our stock were to be delisted from the NASDAQ Global
Market. The NASDAQ Global Market imposes a requirement for continued
listing that the value of shares publicly held, excluding those held by
directors, officers and beneficial owners, exceed certain minimums. A
potential future delisting of our common stock could result in significantly
reduced volume of our common stock traded, more limited press coverage, reduced
interest by investors in the common stock, adverse effects on the trading
market, downward pressure on the price for and liquidity of our stock, and
reduced ability to issue additional securities or to secure additional
financing.
Item 2.
Unregistered Sales of Equity
Securities and Use of Proceeds
Since
2004, we have repurchased a total of 1,568,845 shares of our common stock at a
total cost of $8.4 million under our repurchase program authorized by our Board
of Directors. Share repurchases may be made from time to time in both
open market and private transactions, as conditions warrant, at then prevailing
market prices. As of June 30, 2008, $2.5 million remained available
for share repurchases under the program. The current repurchase program is
expected to remain in effect through February 2009, unless earlier terminated by
the Board or completed.
There was
no activity during the quarter ended June 30, 2008.
Item 4.
Submission of Matters to a
vote of Security Holders
We held
our annual meeting of shareholders on May 15, 2008. Two matters were voted upon
and approved by our shareholders. The presentation below describes
the matters voted upon and the results of the shareholder vote.
|
|
|
|
|
John
H. Bauer
|
|
12,265,213
|
|
95,674
|
Kathryn
Hatch
|
|
12,209,923
|
|
150,964
|
William
C. Keiper
|
|
12,274,013
|
|
86,874
|
Kenneth
Kirkpatrick
|
|
12,201,366
|
|
159,521
|
Firoz
H. Lalji
|
|
12,265,003
|
|
95,884
|
All of
the foregoing candidates were elected.
2. Ratification
of appointment of Grant Thornton LLP as our independent registered public
accounting firm for the fiscal year ending December 31, 2008.
|
|
|
|
|
|
|
12,286,143
|
|
73,188
|
|
1,556
|
|
0
|
The
foregoing proposal was approved.
Item 6.
Exhibits
Exhibit
No.
|
Description
|
Filed
Herewith
|
Incorporated
by Reference
|
|
|
|
|
Form
|
Exhibit
No.
|
File
No.
|
Filing
Date
|
|
Summary
of Zones, Inc. Special Committee Compensation
|
X
|
|
|
|
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 and the regulations promulgated thereunder
|
X
|
|
|
|
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 and the regulations promulgated thereunder
|
X
|
|
|
|
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and the regulations promulgated thereunder
|
X
|
|
|
|
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and the regulations promulgated thereunder
|
X
|
|
|
|
|
Signatures
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Firoz
H. Lalji, Chairman and Chief Executive Officer
|
|
|
|
|
|
|
|
|
|
|
|
Ronald
P. McFadden, Chief Financial
Officer
|
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