PC Connection, Inc. — Q1 2014 Form 10-Q
Business context and period: PC Connection is a value-added reseller of IT products and services, serving SMB, large-account, and public-sector customers. This unaudited report covers the three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise noted. Amounts below are in millions of dollars except per-share data.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Net sales | $559.8 | $505.4 |
| Gross profit; gross margin | $72.8; 13.0% | $66.8; 13.2% |
| SG&A; as % of sales | $61.1; 10.9% | $56.7; 11.2% |
| Operating income; operating margin | $11.7; 2.1% | $10.1; 2.0% |
| Net income | $7.1 | $6.1 |
| Basic and diluted EPS | $0.27 | $0.23 |
| Operating cash flow | $23.8 | $19.0 |
| Capital expenditures, net investing cash flow | $1.5 purchases; $(1.5) net cash used | $1.7 purchases; $(1.7) net cash used |
| Cash and cash equivalents | $64.9 | $42.5 at Dec. 31, 2013 |
| Total assets; stockholders’ equity | $490.4; $327.1 | $500.9; $319.8 at Dec. 31, 2013 |
Gross margin was 13.0%, down 0.21 percentage points year over year. The filing reports no bank borrowings at quarter-end and the full $50 million revolving credit facility available; it may be increased to $80 million subject to lender approval. The facility expires in February 2017. Accounts payable included $16.1 million under supplier-supported inventory trade-credit arrangements. The filing reports no material changes in market risk.
Changes and operating performance
- Sales rose 10.8%; management attributed growth across all three segments partly to customers upgrading ahead of the April 2014 end of Windows XP support.
- Segment sales: SMB $253.5 million, up 7.5%; Large Account $200.9 million, up 7.8%; Public Sector $105.4 million, up 26.4%. Public Sector growth included stronger education and federal sales.
- Gross margin fell as lower-margin desktop and notebook sales increased. Large Account margin improved, while SMB and Public Sector margins declined.
- SG&A increased 7.7% in dollars, primarily from personnel costs, variable compensation, and investment in solution sales and support; it declined as a percentage of sales. Operating income increased 16.0% and net income increased 16.9%.
- Public Sector reported an operating loss of $1.9 million, compared with a $1.5 million loss in Q1 2013. SMB and Large Account operating income increased to $7.8 million each.
Outlook, risks, and unusual items
- Management expects cash on hand, operating cash flow, and available credit to cover requirements for at least the next 12 months. Expected capital expenditures for that period are $8–$10 million; lease and other contractual payments are approximately $3.7 million.
- The company is considering further IT-system investment; if fully implemented, incremental capital costs could exceed $20 million over the next three to five years. Management cautions that results depend on growing higher-margin services enough to cover added service-engineer costs.
- Key challenges include revenue and gross-margin growth, salesforce recruitment and productivity, SG&A control, supplier direct-sales efforts, and changing IT demand. A decline in demand could materially affect operating cash flow.
- A multi-state unclaimed-property audit remains in progress. Management says known and estimated liabilities are provided for, but the ultimate outcome is not yet determinable; additional assessments could materially adversely affect financial results and cash flows. Other ordinary-course legal matters, including patent claims, were not expected by management to have a material effect.
- After quarter-end, the company amended its headquarters lease with an entity affiliated with its chairman and a director/employee. The five-year extension requires monthly rent of $104,434, with an option for one additional five-year term.
- Management reported disclosure controls were effective at the reasonable-assurance level and no material change in internal control over financial reporting during the quarter. The company noted Q1 results may not indicate results for the full year.
Important facts for investors to verify
- Whether the Windows XP-related upgrade demand and public-sector growth continue beyond Q1, and whether product mix allows gross margins to recover.
- Progress in solution-services growth relative to the planned hiring and IT-system investment costs.
- Outcome and possible financial exposure from the unclaimed-property and other tax audits.
- Compliance with credit-facility covenants and continued availability of the full borrowing capacity.
- Terms and related-party governance review of the headquarters lease extension.