PC Connection, Inc. — Q3 2018 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2018. Financial amounts below are in millions of dollars unless noted. The filing is unaudited.
Business context and reporting period
PC Connection is an IT solutions reseller and services provider operating through Business Solutions, Enterprise Solutions, and Public Sector Solutions. It sells hardware, software, and services through sales teams and online channels. Comparisons with 2017 require care: the company adopted ASC 606 on January 1, 2018 using the modified retrospective method, without restating prior periods.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $658.5 | $729.2 | $1,990.0 | $2,149.6 |
| Gross profit | $100.4 | $96.1 | $304.3 | $282.5 |
| Gross margin | 15.3% | 13.2% | 15.3% | 13.1% |
| Operating income | $19.0 | $21.7 | $59.4 | $55.6 |
| Operating margin | 2.9% | 3.0% | 3.0% | 2.6% |
| Net income | $13.8 | $13.1 | $43.3 | $34.1 |
| Diluted EPS | $0.51 | $0.49 | $1.61 | $1.27 |
Cash flow and liquidity: Nine-month operating cash flow was $81.3 million, versus $28.4 million in 2017; investing cash outflow was $15.6 million and financing cash outflow was $13.4 million. Cash increased $52.3 million to $102.2 million at September 30. Current assets were $617.1 million and current liabilities $209.0 million. The company had no bank borrowings and $50.0 million available under its credit facility, which expires in February 2022. No material debt balance was reported.
Other financial metrics: SG&A was $81.5 million, or 12.4% of sales, in Q3 and $244.9 million, or 12.3%, for nine months. The effective tax rate was 27.8% in Q3 and 27.6% for nine months. The company paid a special dividend of $0.34 per share ($9.1 million total) and repurchased $4.4 million of treasury shares during the nine-month period.
Changes versus the prior comparable period
- Reported Q3 sales declined 9.7%, and nine-month sales declined 7.4%. Management attributed the reported declines primarily to ASC 606 presentation changes: certain cloud, security-software, and software-maintenance sales are now recorded net as an agent rather than gross as principal. This reduced both revenue and cost of sales, rather than gross profit, for those transactions.
- Under the prior revenue-recognition guidance, management said Q3 sales would have been $766.3 million, up 5.1% year over year. The filing does not provide a comparable consolidated nine-month sales growth rate on that basis.
- Gross profit and gross margin increased in both periods, supported by higher invoice selling margins, more net-basis revenue, and, in some segments, improved product mix and agency fees. SG&A rose 9.5% in Q3 and 7.9% for nine months, including personnel, solution-selling, and allocated headquarters costs.
- Q3 operating income decreased $2.8 million as higher SG&A more than offset higher gross profit. Nine-month operating income increased $3.7 million. Net income rose in both periods, helped by lower tax rates following the 2017 Tax Cuts and Jobs Act.
- Segment performance was mixed. Q3 reported sales fell 15.7% in Business Solutions, 0.9% in Enterprise Solutions, and 13.2% in Public Sector Solutions. For nine months, Enterprise Solutions sales were roughly flat, while Business Solutions and Public Sector Solutions declined 9.6% and 16.7%, respectively. ASC 606 significantly affects these reported comparisons.
Outlook, commentary, risks, and unusual items
- Management expects 2018 corporate income tax rates of 27%–29%, subject to state taxes, valuation reserves, and uncertain tax positions.
- Management expects $14–$16 million of capital expenditures over the next 12 months and approximately $3.5 million of lease and other contractual-obligation payments. The company’s multiyear IT infrastructure upgrade had incurred $12.4 million of capital expenditures through September 30; a further $8–$9 million was expected over the next nine to twelve months.
- Management believes cash, operating cash generation, and the available credit line will fund working capital, planned capital expenditures, and other needs for at least the next 12 months. It cautioned that weaker IT-product demand could materially affect operating cash flow.
- Key business risks include rapid technology change and inventory obsolescence, product availability and allocation, dependence on vendors and vendor support, direct sales by manufacturers, competition and pricing pressure, economic conditions and IT spending, and recruiting and retaining sales and technical personnel. Management also noted that expanding higher-margin services requires investment in skilled engineers and may pressure results if service revenue does not grow sufficiently.
- The company is subject to ordinary-course legal claims, including patent matters; management does not expect them to have a material effect. State audits and other assessments could result in additional liabilities with potentially material adverse effects. The company reported no material changes in market risks and no material change in internal control over financial reporting; disclosure controls were considered effective.
- ASC 606 increased opening retained earnings by $1.2 million. Its Q3 and nine-month net-basis presentation reduced reported sales and cost of sales substantially; the filing’s reconciliation also shows reported net income was $0.2 million lower for Q3 and $0.6 million lower for nine months than under the prior guidance.
Important facts for investors to verify
- Assess underlying sales growth using the ASC 606 reconciliation and segment disclosures, rather than relying only on reported revenue declines.
- Track whether improved gross margins and higher-margin solution sales can offset rising SG&A and continued investment in personnel and IT systems.
- Monitor Public Sector Solutions performance, including the nonrecurrence of a large 2017 federal desktop sale and the reported decline in higher-education sales.
- Verify working-capital trends: days sales outstanding were 50 days versus 43 a year earlier, although management said they would have been unchanged excluding ASC 606; inventory increased from year-end.
- Confirm delivery of planned IT investments and service-revenue growth, as well as continued compliance with credit-facility covenants. The facility’s maximum funded-debt ratio is 2.0-to-1.0; the company reported its actual ratio at 0.01-to-1.0 and stockholders’ equity of $523.2 million against a $402.3 million minimum requirement.