Our management's discussion and analysis of our financial condition and results of operations include the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated. See "Item 1A. Risk Factors."

OVERVIEW

We are a leading direct marketer of a wide range of information technology, or IT, products and services-including computer systems, software and peripheral equipment, networking communications, and other products and accessories that we purchase from manufacturers, distributors, and other suppliers. We also offer a growing range of installation, configuration, repair, and other services performed by our personnel and third-party providers. We operate through three primary business segments: (a) consumers and small- to medium-sized businesses, or SMBs, through our PC Connection Sales subsidiaries, (b) large enterprise customers, or Large Account, through our MoreDirect subsidiary, and (c) federal, state, and local government and educational institutions, or Public Sector, through our GovConnection subsidiary.

We generate sales through (i) outbound telemarketing and field sales contacts by account managers focused on the business, education, and government markets,
(ii) our websites, and (iii) inbound calls from customers responding to our catalogs and other advertising media.

As a value added reseller in the IT supply chain, we do not manufacture IT hardware or software. We are dependent on our suppliers that consist of manufacturers and distributors that historically have sold only to resellers rather than directly to end users. Certain manufacturers have on many occasions attempted to sell directly to our customers, thereby eliminating our role. Consolidation in this industry is more evident than ever, as further streamlining of our supply chain occurs. If more of our suppliers were to succeed in selling to our customers directly, including the electronic distribution of software products, our financial condition, results of operations, and cash flows could be negatively affected.

Market conditions and technology advances significantly affect the demand for our products and services. Virtual delivery of software products and advanced Internet technology providing customers enhanced functionality have substantially increased customer expectations, requiring us to invest more heavily in our own IT development to meet these new demands. As buying trends change and electronic commerce continues to grow, customers become more sophisticated and have more choices than ever before. Customers are also better able to make price comparisons through the Internet, thereby increasing price competition. These conditions could have a negative effect on our financial condition, results of operations, and cash flows.

The primary challenges we face in effectively managing our business are
(1) maintaining or increasing our revenues in the face of a worsening global recession, while at the same time, maintaining, if not improving, our gross profit margins in all three business segments, (2) recruiting, retaining, and improving the productivity of our sales personnel, and (3) effectively controlling our SG&A expenses over an expected lower sales base. With declines in spending projected in the overall IT industry, any significant sales growth for us must come through increased market share. Competition is expected to be even more intense in the future, which could put more pressure on margins. Given the softness in customer demand, management implemented cost reductions beginning late in the third quarter of 2008 to reduce expenses to be in line with lower sales volumes. We lowered headcount in sales support areas and implemented various cost reduction programs that are expected to result in annualized savings of $6 million. Given the continued decline in the demand environment, we implemented further cost reductions in the first quarter of 2009 which we believe could result in additional savings of up to $16 million in 2009. We expect to record severance charges of up to $0.6 million in connection with this action.

We believe that more of our customers are seeking total IT solutions, rather than simply specific IT products. Through the formation of our services subsidiary, ProConnection, Inc., we are able to provide customers complete IT solutions, from identifying their needs, to designing, developing, and managing the

integration of products and services to implement their IT projects. Such service offerings carry much higher margins than traditional product sales. Additionally, the technical certifications of our service engineers permit us to offer higher-end, more complex products that also carry higher gross margins. We expect these service offerings and technical certifications to continue to play a role in sales generation and gross margins in this competitive environment.

We seek to recruit, retain, and increase the productivity of our sales personnel through training, mentoring, financial incentives based on performance, and updating and streamlining our information systems to make our operations more efficient. We are currently undertaking a major modification and upgrade of our sales order and customer management system that are expected to improve sales productivity beginning in the second half of 2009. In addition, as stated above, we continue to actively monitor and manage our expense structure in order to obtain better leverage of our operating costs.

RESULTS OF OPERATIONS

The following table sets forth information derived from our consolidated statements of income expressed as a percentage of net sales for the periods indicated.

                                                        Years Ended December 31,
                                                    2008          2007          2006
   Net sales (in millions)                        $ 1,753.7     $ 1,785.4     $ 1,635.7

   Net sales                                          100.0 %       100.0 %       100.0 %
   Gross profit                                        12.3          12.3          12.2
   Selling, general and administrative expenses        10.7          10.2          10.6
   Goodwill impairment                                  0.5            -             -
   Special charges                                      0.1            -            0.1
   Income from operations                               1.0           2.1           1.5

Net sales decreased by $31.7 million year over year in 2008 as increased Public Sector revenues were offset by revenue declines in the SMB and Large Account segments. Operating margins decreased year over year due to the goodwill impairment charge and higher operating costs, which we attribute to increased IT investments in sales support systems and higher personnel costs.

Sales Distribution

The following table sets forth our percentage of net sales by business segment
and product mix:



                                                Years Ended December 31,
                                              2008         2007        2006
            Business Segment
            SMB                                  52 %         54 %       54 %
            Large Account                        27           29         30
            Public Sector                        21           17         16

            Total                               100 %        100 %      100 %

            Product Mix
            Notebooks and PDAs                   15 %         16 %       17 %
            Video, Imaging and Sound             15           14         13
            Desktop/Servers                      13           14         14
            Software                             13           13         13
            Net/Com Products                     10            8          8
            Printers and Printer Supplies         9           10         10
            Storage Devices                       9            9          9
            Memory and System Enhancements        4            5          5
            Accessories/Other                    12           11         11

            Total                               100 %        100 %      100 %

We experienced year-over-year sales declines in 2008 in all but three product categories, which we attribute to the weakened economy and the associated decline in IT spending. Our highest year-over-year growth category was Net/Com Products, which grew 27% in 2008 compared to the prior year, reflecting industry demand for total IT solutions products. Sales of Accessories/Other also grew 4% year over year, primarily due to increased sales of consumer electronics and power management products.

Gross Profit Margins

The following table summarizes our overall gross profit margins, as a percentage
of net sales, for the last three years:



                                       Years Ended December 31,
                                    2008         2007         2006
                  Segment
                  SMB                 13.9 %       13.4 %       13.3 %
                  Large Account       11.0         11.2         10.8
                  Public Sector        9.6         10.5         11.2
                  Total               12.3 %       12.3 %       12.2 %

Consolidated gross profit dollars decreased in 2008 by $4.1 million compared to 2007 primarily due to the decline in net sales, as consolidated gross profit margin was unchanged year over year. Gross profit margins were unchanged as lower invoice product margins in 2008 were offset by increased vendor consideration recorded as a reduction to cost of sales compared to 2007.

Cost of Sales and Certain Other Costs

Cost of sales includes the invoice cost of the product, direct costs of packaging, inbound and outbound freight, and provisions for inventory obsolescence, adjusted for discounts, rebates, and other vendor allowances, including those pursuant to Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"). Direct operating expenses relating to our purchasing function and receiving, inspection, internal transfer, warehousing, packing and shipping, and other expenses of our distribution center are included in SG&A expenses. Accordingly, our gross margins may not be comparable to those of other entities who include all of the costs related to their distribution network in cost of goods sold. Such costs, as a percentage of net sales for the periods reported, are as follows:

Years Ended December 31, 2008 2007 2006 0.69 % 0.65 % 0.67 %

Operating Expenses

The following table breaks out our more significant operating expenses for the
last three years (in millions of dollars):



                                                Years Ended December 31,
                                              2008         2007        2006
            Personnel costs                 $   124.0     $ 121.4     $ 117.3
            Advertising                          19.5        19.9        13.3
            Facilities operations                 9.5         9.1         9.0
            Credit card fees                      7.7         8.0         8.1
            Depreciation and amortization         7.0         6.8         7.0
            Professional fees                     8.1         5.4         5.8
            Bad debts                             1.7         1.0         2.3
            Other-net                             9.2        10.0        11.1

            Total                           $   186.7     $ 181.6     $ 173.9

            Percentage of net sales              10.7 %      10.2 %      10.6 %

Operating income in 2008 declined compared to 2007 due to higher personnel costs, increased professional fees, and the goodwill impairment charge. Professional fees increased due to increased IT investments in sales support systems. We are currently undertaking a major modification and upgrade of our sales order processing and customer management system that are expected to improve sales productivity in the second half of 2009. While we plan to continue our focus on controlling discretionary expenditures, we expect that our SG&A expense may vary depending on changes in sales volume, as well as the levels of continued investments in key growth initiatives such as enhancing our sales training, improving marketing programs, and deploying next generation technology to support the sales organization.

Personnel costs represent the majority of our operating expenses, with sales personnel representing the largest portion of these costs. The year-over-year increase in personnel costs resulted from annual merit increases, higher share-based compensation, and the hiring of services personnel in 2008. Increased bad debt expense also negatively affected operating income.

YEAR-OVER-YEAR COMPARISONS

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Net sales decreased 1.8% to $1,753.7 million in 2008 from $1,785.4 million in
2007 due to decreases in the SMB and Large Account segments. Changes in net
sales and gross profit by business segment are shown in the following table
(dollars in millions):



                                    Years Ended December 31,
                                 2008                      2007
                                       % of                      % of          %
                          Amount     Net Sales      Amount     Net Sales     Change
         Sales:
         SMB             $   919.1        52.4 %   $   964.5        54.0 %     (4.7 %)
         Large Account       475.3        27.1         514.8        28.8       (7.7 )
         Public Sector       359.3        20.5         306.1        17.2       17.4

         Total           $ 1,753.7       100.0 %   $ 1,785.4       100.0 %     (1.8 %)

         Gross Profit:
         SMB             $   128.0        13.9 %   $   129.3        13.4 %     (1.0 %)
         Large Account        52.5        11.0          57.5        11.2       (8.7 )
         Public Sector        34.3         9.6          32.2        10.5        6.5

         Total           $   214.8        12.3 %   $   219.0        12.3 %     (1.9 %)

• Net sales for the SMB segment decreased across most product and customer sectors. Corporate sales declined by 4% year over year, reflecting the continued softening in IT spending by small- and medium-sized businesses. Consumer sales continued to decline, reflecting our focus on more diverse marketing programs designed to reach our business customers and the general decline in consumer spending. Average annualized sales productivity decreased 6% year over year in 2008 compared to 2007. Sales representatives for our SMB segment totaled 453 at December 31, 2008, compared to 470 at December 31, 2007.

• Net sales for the Large Account segment decreased year over year, reflecting the industry-wide decline in IT spending by large account customers. Sales representatives for our Large Account segment totaled 94 at December 31, 2008, compared to 96 at December 31, 2007. Average annualized sales productivity increased year over year by 2% in 2008 reflecting improved sales processes and reduced headcount.

• Net sales for the Public Sector segment in 2008 increased by 17.4% year over year primarily due to increased sales made under existing federal government contracts. Average annualized sales

Gross profit decreased in dollars in 2008 compared to 2007 as shown by the following:

• Gross profit for the SMB segment declined year over year in 2008 due to decreased net sales, as gross profit margins increased over the same period. We attribute the increase in gross profit margin to additional vendor consideration, offset partially by increased competitive pricing pressures in 2008 compared to the prior year.

• Gross profit for the Large Account segment decreased year over year in both dollars and as a percentage of net sales. The decline in gross profit margins was attributable to aggressive competitive pricing as large account customers increasingly curtailed IT spending in the second half of 2008. Additional vendor consideration partially offset such pricing pressure.

• Gross profit for the Public Sector segment increased in dollars in 2008 but decreased as a percentage of net sales compared to 2007. Declines in invoice product and freight margins and lower agency fee revenues, which are recorded on a net basis, adversely impacted gross profit margins in 2008 compared to the prior year.

Selling, general and administrative expenses increased in dollars and as a percentage of sales in 2008 compared to 2007.

SG&A expenses attributable to our operating segments and Headquarters/Other group are summarized below (dollars in millions):

                                             Years Ended December 31,
                                     2008                    2007
                                          % of                    % of          %
                              Amount    Net Sales     Amount    Net Sales     Change
         SMB                  $ 110.2        12.0 %   $ 105.0        10.9 %      5.0 %
         Large Account           30.3         6.4        29.0         5.6        4.5
         Public Sector           35.0         9.7        30.6        10.0       14.4
         Headquarters/Other      11.2                    17.0

         Total                $ 186.7        10.6 %   $ 181.6        10.2 %      2.8 %

• SG&A expenses for the SMB segment increased year over year in both dollars and as a percentage of net sales. Increased personnel costs, higher bad debt expense, and additional usage of centralized headquarter services led to increased operating expenses in 2008. Despite a decrease in variable compensation associated with lower gross margins, personnel expense increased due to the higher travel and training costs experienced in 2008. The operating costs of corporate headquarters and other support functions are charged to the reportable operating segments based on their estimated usage of the underlying functions.

• SG&A expenses for the Large Account segment increased in dollars and as a percentage of net sales compared to the prior year period. Additional usage of centralized headquarter services was partly offset by reduced variable compensation associated with lower gross margins in 2008 compared to the prior year period.

• SG&A expenses for the Public Sector segment increased in dollars but decreased as a percentage of net sales in 2008 due to the leveraging of such expenses over a larger sales base. The year-over-year dollar

• SG&A expenses for the Headquarters/Other group decreased in dollars year over year as increased usage by the operating segments offset increased investments in information technology systems, annual merit increases, and higher share-based compensation expense in 2008 compared to the prior year. As discussed in Note 15, "Segment and Related Disclosures" to the Consolidated Financial Statements, the "Headquarters/Other" group provides services to the three reportable operating segments in areas such as finance, human resources, information technology, product management, and marketing. Most of the operating costs associated with such corporate headquarters functions are charged to the operating segments based on their estimated usage of the underlying functions. Certain headquarters costs relating to executive oversight functions are not allocated to the operating segments and are included in this group's expenses.

Goodwill impairment charges totaling $8.8 million, $5.4 million net of taxes, were recorded in the year ended December 31, 2008. We did not record any impairment charges in 2007. As discussed in Note 2, "Goodwill and Other Intangible Assets" to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K, the 2008 non-cash impairment charges represented the entire goodwill balances carried by our SMB and Public Sector segments. Goodwill impairment, pre-tax by segment, for the year ended December 31, 2008 is summarized below (dollars in millions):

                                               2008
                               Public Sector   $ 7.6
                               SMB               1.2

                               Total           $ 8.8

Special charges totaled $1.4 million and $0.5 million for the years ended December 31, 2008 and 2007, respectively. Such charges related to management restructuring costs, classified as workforce reductions in the table below. A roll forward of liabilities related to special charges for the two years ended December 31, 2008, is shown below (dollars in millions):

                                                      Workforce
                                                      Reduction
                  Balance, December 31, 2006         $       0.2
                  Charges                                    0.5
                  Cash Payments                             (0.2 )

                  Balance, December 31, 2007         $       0.5

                  Charges                                    1.4
                  Cash Payments                             (0.6 )

                  Liabilities at December 31, 2008   $       1.3

Income from operations decreased by $18.9 million to $17.9 million for the year ended December 31, 2008, from $36.8 million in 2007. Income from operations as a percentage of net sales decreased from 2.1% in 2007 to 1.0% in 2008. This decrease was attributable to the decrease in net sales, goodwill impairment charges, and increased operating expenses in 2008 as a percentage of net sales, as discussed above.

Interest expense was $0.7 million in 2008 compared to $0.9 million in 2007. Interest expense decreased in 2008 due to lower borrowing levels in 2008 compared to the prior year, as well as reduced interest expense associated with our capital lease in 2008 compared to 2007. Interest and other income was largely unchanged year over year despite higher cash balances maintained in 2008 compared to 2007 due to lower interest rates received on such balances in 2008 compared to the prior year.

Our effective tax rate was 42.4% for 2008 and 37.2% for 2007. Our higher effective tax rate in 2008 was generally due to increased state tax expense associated with filing in additional states as a result of our business expansion, as well as a reduction in state credit carryforwards. Our 2007 tax rate was favorably impacted by the consolidated filing of certain state income tax returns. We anticipate that our effective tax rate will be in the range of 40.0% to 41.0% in 2009.

Net income decreased by $12.6 million to $10.4 million in 2008 from $23.0 million in 2007, principally as a result of the decrease in income from operations.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net sales increased 9.2% to $1,785.4 million in 2007 from $1,635.7 million in
2006 due to increases in all three business segments. Changes in net sales and
gross profit by business segment are shown in the following table (dollars in
millions):



                                    Years Ended December 31,
                                 2007                      2006
                                       % of                      % of          %
                          Amount     Net Sales      Amount     Net Sales     Change
         Sales:
         SMB             $   964.5        54.0 %   $   887.0        54.2 %      8.7 %
         Large Account       514.8        28.8         482.9        29.5        6.6
         Public Sector       306.1        17.2         265.8        16.3       15.2

         Total           $ 1,785.4       100.0 %   $ 1,635.7       100.0 %      9.2 %

         Gross Profit:
         SMB             $   129.3        13.4 %   $   118.3        13.3 %      9.3 %
         Large Account        57.5        11.2          52.3        10.8        9.9
         Public Sector        32.2        10.5          29.7        11.2        8.4

         Total           $   219.0        12.3 %   $   200.3        12.2 %      9.3 %

• Net sales for our SMB segment benefited from our 17% growth in corporate outbound sales in 2007 compared to 2006. We believe such growth is attributable to this segment's sales representatives adding new customers and acquiring a greater share of existing customers' IT purchases. Sales growth was adversely impacted by a decline in consumer sales, as both inbound telephone sales and internet consumer sales decreased year over year in 2007. These changes reflect our continued focus on more diverse marketing strategies and programs designed to reach our business customers. Average annualized sales productivity in 2007 increased by 10% compared to 2006 in the SMB segment due to increased tenure of our sales representatives. Sales representatives for our SMB segment totaled 470 at December 31, 2007, compared to 473 at December 31, 2006.

• Net sales for our Large Account segment increased year over year as its seasoned sales representatives increased sales to existing customers and added new accounts. Sales representatives for our Large Account segment totaled 105 at December 31, 2007, down from 119 at the end of 2006. Average annualized sales productivity in 2007 improved year over year by 18%, reflecting the success of this segment's consultative sales and solutions selling model.

• Net sales for our Public Sector segment increased year over year due to the additional sales made in 2007 under recently awarded federal and higher education contracts. Average annualized sales productivity in 2007 increased by 10% year over year reflecting the improvement in average sales representative tenure. Sales representatives for our Public Sector segment totaled 117 at December 31, 2007, up from 110 at December 31, 2006.