PC Connection, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. The company is an IT solutions reseller serving SMB, Large Account, and Public Sector customers. Financial statements are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $729.2m | $708.5m | $2,149.6m | $1,957.0m |
| Gross profit | $96.1m | $97.0m | $282.5m | $273.0m |
| Gross margin | 13.2% | 13.7% | 13.1% | 14.0% |
| Operating income | $21.7m | $22.4m | $55.6m | $58.6m |
| Operating margin | 3.0% | 3.2% | 2.6% | 3.0% |
| Net income | $13.1m | $13.6m | $34.1m | $35.1m |
| Diluted EPS | $0.49 | $0.51 | $1.27 | $1.32 |
- Cash flow, nine months: Operating cash flow was $28.4m versus $39.8m in 2016; capital expenditures were $7.9m versus $8.7m. Investing cash use was $7.9m, compared with $42.7m in 2016, which included the Softmart acquisition. Financing cash use was $7.3m versus $10.4m, including special dividends of $9.0m and $10.6m, respectively. Cash increased $13.2m to $62.3m.
- Liquidity and debt: Current assets were $561.5m and current liabilities $200.1m at September 30, 2017. The company had no bank borrowings and had its full $50.0m accounts-receivable-backed credit facility available; it may be increased to $80.0m subject to lender approval. Stockholders’ equity was $469.9m.
- Working capital indicators: Receivables were $382.7m and inventory $106.7m. Management reported days sales outstanding of 43 days, versus 42 a year earlier, and inventory turns of 22 versus 23.
Material changes and operating trends
- Q3 sales increased 2.9% year over year, led by SMB and Large Account growth; Public Sector sales declined 1.0%. Software and desktop sales grew 14% and 8%, respectively, according to management.
- Q3 gross profit fell despite higher sales. Management attributed margin pressure to competitive pricing, lower invoice selling margins, and reduced vendor funding. Segment gross margins declined year over year: SMB 14.9% from 15.5%, Large Account 12.7% from 13.4%, and Public Sector 11.0% from 11.1%.
- For the first nine months, sales grew 9.8%, with growth in all three segments: SMB 5.7%, Large Account 13.7%, and Public Sector 11.2%. Large projects and government contract activity contributed to growth. Gross margin nevertheless contracted to 13.1% from 14.0%.
- Nine-month SG&A increased 5.8% to $226.9m, but decreased as a share of sales to approximately 10.6% from 11.0%. Operating income and net income declined, reflecting margin pressure and higher SG&A. The 2017 nine-month tax provision included a $1.0m discrete benefit from equity-award tax accounting; the effective tax rate was 38.7% versus 40.0%.
Outlook, risks, and notable items
- Management said cash, operating cash generation, and available credit should fund working capital, capital expenditures, and other requirements for at least the next 12 months. Expected capital expenditures for the next 12 months were $18m–$20m, with approximately $5m of lease and other contractual payments.
- A multi-year IT infrastructure upgrade began in October 2017. The company expects related capital investment of $20m–$25m over the next two to three years and anticipates higher depreciation and potentially higher SG&A as assets enter service.
- Management highlighted risks from competitive pressure and pricing, vendor funding and supplier relationships, technology change and inventory obsolescence, economic activity and IT spending, and the cost of recruiting advanced-solution engineers if related revenue growth is insufficient.
- The company expects to adopt the new revenue-recognition standard in Q1 2018 using the full retrospective method. It tentatively expects earlier recognition for certain FOB shipping-point hardware sales; analysis of other revenue streams and inventory-related arrangements remained underway. Management also expected expanded revenue disclosures.
- Legal proceedings, including patent matters, were not expected by management to have a material effect. However, additional liabilities from state sales and income tax, employment, and other audits could have a material adverse effect. No material change in market risks was reported; disclosure controls were deemed effective.
Important facts for investors to verify
- Whether gross-margin pressure and lower vendor funding persist, and whether sales growth translates into stronger operating income.
- How large-project and Public Sector sales develop, given their contribution to growth and potential effect on product mix and margins.
- Whether working-capital trends, including higher inventory and slightly longer receivable collection time, affect operating cash generation.
- The final financial-statement and comparative-period effects of adopting the revenue-recognition standard in 2018.
- Funding, execution, and expense impacts of the multi-year IT upgrade, alongside the company’s capital-spending outlook and available credit.