Business context and reporting period
PC Connection, Inc. is an IT products and solutions reseller serving small and midsize businesses, enterprise customers, and public-sector organizations through its Business Solutions, Enterprise Solutions, and Public Sector Solutions segments. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018; financial statement amounts below are in millions except per-share data.
The company adopted ASC 606 on January 1, 2018 using the modified retrospective method. Prior-period figures were not restated, so reported revenue and margin comparisons are affected by presentation changes, including recording certain software and cloud transactions net as an agent rather than gross as a principal.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $706.6 | $749.8 | $1,331.5 | $1,420.4 |
| Gross profit | $107.5 | $99.7 | $203.8 | $186.4 |
| Gross margin | 15.2% | 13.3% | 15.3% | 13.1% |
| Operating income | $24.9 | $22.4 | $40.4 | $33.9 |
| Operating margin | 3.5% | 3.0% | 3.0% | 2.4% |
| Net income | $18.2 | $13.6 | $29.5 | $21.0 |
| Diluted EPS | $0.68 | $0.51 | $1.10 | $0.78 |
- For the six months, operating cash flow was $41.5, versus cash used of $9.8 in the prior-year period. Investing cash outflow was $9.9, principally equipment purchases; financing cash outflow was $12.9, primarily the $9.1 special dividend and $4.4 of treasury-share purchases. Cash rose $18.7 to $68.7.
- At June 30, cash was $68.7, accounts receivable $464.0, inventory $107.4, current assets $647.3, and current liabilities $253.3. The company had no bank borrowings and the full $50.0 credit facility was available; it may be increased to $80.0 with lender approval for permitted purposes. Total liabilities were $271.3 and stockholders’ equity was $509.7.
- Six-month segment sales were $533.3 for Business Solutions, $558.3 for Enterprise Solutions, and $239.8 for Public Sector Solutions. Segment operating income was $20.1, $30.0, and a loss of $2.6, respectively; Headquarters/Other recorded a $7.1 loss.
Material changes versus prior comparable periods
- Reported sales fell 5.8% in Q2 and 6.3% in the first half, but those comparisons include ASC 606 reductions of $113.2 and $188.8, respectively. The filing presents Q2 sales of $819.8 and first-half sales of $1,520.2 without the new standard, versus prior-year reported sales of $749.8 and $1,420.4; these are not fully like-for-like reported comparisons.
- Management attributed higher gross profit to improved invoice selling margins, higher-margin advanced solutions, and agency fees. ASC 606’s net presentation raised reported gross-margin percentages while reducing both sales and cost of sales. SG&A rose to $82.5 in Q2 and $163.4 for the first half; SG&A as a share of reported sales increased to 11.7% and 12.3%, respectively.
- Business Solutions and Public Sector Solutions had lower reported sales in Q2; Enterprise Solutions was nearly flat. For the first half, Enterprise Solutions grew slightly, while Business Solutions and Public Sector Solutions declined. Public-sector first-half sales were also affected by a large federal desktop sale in the prior-year period that did not recur and lower higher-education sales.
- The effective tax rate declined to 27.5% for both Q2 and the first half, from 39.5% and 38.0%, respectively, reflecting the lower federal corporate tax rate enacted in 2017. ASC 606’s transition adjustment increased opening retained earnings by $1.2; the filing states adoption had no net impact on cash flows.
Outlook, risks, contingencies, and unusual items
- Management expects funds from operations and available credit to meet working-capital, capital-expenditure, and other needs for at least the next 12 months. It expects $14–$16 of capital expenditures over the next 12 months, and $10–$12 of additional spending on the multi-year IT upgrade over the next 12–15 months. The company had incurred $10.0 on that initiative through June 30, 2018.
- Management expects a 2018 corporate income tax rate of 27%–29%. The filing gives no revenue or earnings guidance.
- Management identifies risks including rapid technology change and inventory obsolescence, supplier dependence and direct-to-customer sales, competition and pricing, availability of products, economic conditions and IT spending, and recruiting and retaining sales and technical personnel. It cautions that service-engineer investment may pressure results if service revenue does not grow enough to offset added costs.
- Days sales outstanding were 53 days at June 30, 2018 versus 47 days a year earlier; management says they would have been 46 days in both periods excluding ASC 606. Inventory increased $11.6 from year-end, partly due to future backlog and shipments not yet received by customers.
- Customary legal claims, including patent matters, are not expected by management to have a material effect. However, additional liabilities from state sales and income tax, employment, or other audits could have a material negative effect. The $50.0 credit facility has financial and operating covenants, including a maximum funded-debt ratio of 2.0:1.0; the company reported compliance and a ratio of 0.01:1.0.
- The company repurchased 53,221 shares in April under its existing $30.0 authorization, at an average $26.05 per share. It paid a $0.34-per-share special dividend during the first half.
Important facts for investors to verify
- Assess underlying sales and margin trends using the ASC 606 reconciliation, given that the prior period was not restated and the new presentation materially reduced reported sales.
- Monitor segment performance, particularly the Public Sector Solutions operating loss for the first half and the reasons for weaker public-sector demand.
- Track receivables, DSO, inventory levels, and backlog conversion, including whether working-capital needs remain consistent with management’s liquidity expectations.
- Evaluate the timing, total cost, and expected benefits of the IT-system investment and service-engineer expansion.
- Confirm future tax-rate outcomes, compliance with credit-facility covenants, and any developments in tax audits or other contingencies.