PC Connection, Inc. — FY 2018 Form 10-K
Business context and reporting period. PC Connection is a U.S. IT products and solutions reseller serving small and midsize businesses, large enterprises, and public-sector and education customers through Business Solutions, Enterprise Solutions, and Public Sector Solutions. This annual report covers the fiscal year ended December 31, 2018; quarterly figures below identify the fourth quarter. The company adopted ASC 606 on January 1, 2018 using the modified retrospective method.
Financial performance and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $2,699.5 million | $2,911.9 million |
| Gross profit / gross margin | $411.1 million / 15.2% | $382.1 million / 13.1% |
| SG&A | $324.4 million / 12.0% of sales | $300.9 million / 10.3% of sales |
| Operating income / margin | $85.7 million / 3.2% | $77.5 million / 2.7% |
| Net income | $64.6 million | $54.9 million |
| Diluted EPS | $2.41 | $2.04 |
| Cash from operations | $86.8 million | $19.3 million |
- Fourth quarter: Sales were $709.5 million versus $762.3 million in Q4 2017; gross profit was $106.8 million versus $99.5 million; operating income was $26.3 million versus $21.9 million; and net income was $21.3 million versus $20.7 million. Q4 2018 included $2.6 million of other income, mainly from the contract-dispute resolution.
- Balance sheet and debt: At year-end, cash was $91.7 million, working capital $409.4 million, total assets $805.4 million, and stockholders’ equity $525.9 million. No bank borrowings were outstanding against the $50 million revolving facility, available through February 2022. Accounts payable was $201.6 million.
- Cash flow and investment: Operating cash flow rose to $86.8 million, primarily reflecting earnings, lower receivables, and higher payables, partly offset by inventory growth. Investing cash use was $21.2 million, mainly for IT equipment and capitalized software; financing cash use was $23.9 million, including $15.4 million of share repurchases and a $9.1 million dividend payment.
Material changes versus prior periods
- Reported sales declined 7.3% year over year, but this is not directly comparable because ASC 606 moved certain software, cloud, and maintenance transactions from gross to net presentation. The filing states that sales under the prior accounting guidance would have been $3,104.2 million, up 6.6% from 2017. The standard reduced reported sales and cost of sales; the filing also reports an approximately $0.8 million operating-income effect from the standard’s other adoption impacts.
- Gross profit increased 7.6% and gross margin expanded 210 basis points, supported by higher selling margins, advanced solutions, software-related agency fees, and cash discounts. SG&A rose 7.8%, reflecting personnel and solution-selling investments as well as the lower reported-sales denominator under ASC 606.
- Enterprise Solutions sales rose 2.9% as reported; on the prior accounting basis, management said they would have risen 17.9%. Business Solutions reported sales fell 11.3% but would have increased 3.7% on the prior basis. Public Sector Solutions sales fell 18.5%; the segment recorded a $2.3 million operating loss, versus $1.0 million of operating income in 2017.
- Net income increased 17.8%. In addition to stronger operating income, 2018 included $2.3 million of net gain from a favorable contract-dispute resolution; the $3.0 million cash settlement was received in January 2019.
Outlook, risks, contingencies, and unusual items
- Management expects 2019 capital expenditures of $14–$16 million, including $6–$7 million over the next six to nine months to complete a multiyear IT infrastructure upgrade. It believes operating cash flow, cash on hand, and the available credit line will meet requirements for at least the next 12 months.
- Management expects a 2019 corporate income tax rate of 27%–29%. The company reported no current plans for additional cash dividends in the foreseeable future.
- Key risks include intense price and competitive pressure, changing distribution models and cloud/SaaS adoption, vendor incentive reductions, inventory obsolescence, cybersecurity and systems disruptions, and reliance on a concentrated supplier base. HP products represented 18% of 2018 sales; the five largest suppliers represented 59% of product purchases. Government contract compliance and changes in public-sector spending are additional risks.
- A multistate unclaimed-property audit remains in process; accrued unclaimed-property liabilities were $1.0 million at year-end. Tax and other government audits could result in additional liabilities; $0.9 million of unrecognized tax benefits, including interest and penalties, was excluded from contractual-obligation totals. Management said ordinary-course legal proceedings were not expected to have a material effect, while noting outcomes may be uncertain.
- Operating lease obligations totaled $19.7 million, including $5.0 million due within one year. The company expected the 2019 adoption of lease accounting rules to materially increase balance-sheet assets and liabilities. Two Merrimack facilities leased from an affiliated company had expired lease terms, and amendments were being negotiated.
- Special items included $1.0 million of 2018 restructuring charges, primarily employee separations; the filing says planned restructuring was complete. The company’s 2017 effective tax rate benefited from a $7.7 million deferred-tax revaluation benefit following U.S. tax reform.
Important facts for investors to verify
- Assess year-over-year sales and segment growth on a comparable basis given ASC 606’s gross-to-net presentation changes; verify the economics and durability of software and agency-fee revenue.
- Monitor whether gross-margin improvement and solution-service growth can offset higher personnel and SG&A costs, particularly in the loss-making Public Sector segment.
- Review inventory, days sales outstanding, and cash conversion: reported DSO increased to 52 days from 48, while inventory rose $23.3 million and turns fell to 21; management provides alternative figures excluding ASC 606 effects.
- Separate recurring earnings and cash generation from the one-time contract-dispute gain, and track completion costs and benefits of the IT upgrade.
- Evaluate supplier concentration, HP exposure, public-sector demand, tax and unclaimed-property audit outcomes, and the balance-sheet effect of lease-standard adoption.