PC Connection, Inc. — Q2 2017 Form 10-Q
Business context and period: National IT solutions reseller providing products and services through SMB, Large Account, and Public Sector segments. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $749.8 | $676.2 | $1,420.4 | $1,248.6 |
| Gross profit / margin | $99.7 / 13.3% | $93.9 / 13.9% | $186.4 / 13.1% | $176.1 / 14.1% |
| Operating income / margin | $22.4 / 3.0% | $21.0 / 3.1% | $33.9 / 2.4% | $36.2 / 2.9% |
| Net income | $13.6 | $12.5 | $21.0 | $21.5 |
| Diluted EPS | $0.51 | $0.47 | $0.78 | $0.81 |
- Q2 sales rose 10.9% year over year, with growth in all three segments; Softmart contributed about one-third of the increase. Software, networking, and desktop sales grew 15%, 25%, and 6%, respectively.
- First-half sales rose 13.8%, but gross margin declined 1.0 percentage point and operating margin declined 0.5 point. Operating income fell 6.3% and net income fell 2.3% year over year.
- Gross margin weakened across all segments. Management attributed the declines primarily to lower-margin product and customer mix and large project rollouts. SG&A increased in dollars, mainly from personnel costs, but fell as a share of sales.
- Segment highlights: Q2 sales increased 9.4% in SMB, 12.1% in Large Account, and 11.5% in Public Sector. First-half sales increased 7.1%, 18.2%, and 19.7%, respectively. Public Sector recorded an operating loss of $2.6 million in the first half, compared with $1.0 million of operating income in 2016.
Cash flow, balance sheet, and liquidity
- First-half operating cash flow was negative $9.8 million, versus positive $17.0 million in 2016. Increased receivables and inventory were the main uses of cash; inventory rose $27.7 million from year-end, and receivables rose $15.2 million. Days sales outstanding increased to 47 from 45 a year earlier; inventory turns were 22 in both Q2 periods.
- Cash fell $21.0 million during the first half to $28.1 million at June 30. Investing cash outflow was $4.5 million, principally capital expenditures; financing cash outflow was $6.8 million, including a $9.0 million special dividend ($0.34 per share).
- Current assets were $582.9 million and current liabilities $234.4 million; the resulting current ratio was approximately 2.5. The company had no bank borrowings and the full $50 million revolving facility was available. The facility expires in February 2022 and may be increased to $80 million with lender approval.
- Accounts payable included $27.9 million under supplier-supported inventory financing arrangements. Total liabilities were $256.2 million; the filing reports no outstanding bank debt.
- Management expects available cash, operating cash flows, and the credit facility to cover needs for at least 12 months. Expected next-12-month capital expenditures are $10–$12 million, with approximately $5 million of lease and other contractual payments. Potential IT infrastructure investment could exceed $20 million over one to three years.
Outlook, risks, and notable items
- No specific revenue or earnings guidance is provided. Management cited priorities of growing revenue while improving margins, recruiting and retaining productive sales staff, and controlling SG&A while investing in IT systems and solution-selling personnel.
- Management expects to expand advanced IT solutions and engineering capabilities, which may increase costs; results could weaken if related revenue growth does not offset those costs. IT infrastructure investment and resulting depreciation and SG&A may also rise.
- Key disclosed risks include technology change and inventory obsolescence, product availability and allocation, dependence on vendor support and relationships, direct vendor sales, competition and pricing pressure, and changes in economic activity and IT spending.
- A multi-state unclaimed-property audit remains in progress. Management believes known and estimated liabilities are adequately provided, but says additional assessments could materially adversely affect financial position, results, or cash flows. Other ordinary-course legal matters are not expected by management to have a material effect.
- A $656,000 discrete income tax benefit from equity compensation reduced the first-half tax provision; the first-half effective tax rate was 38.0%, versus 40.5% in 2016. The company adopted inventory measurement guidance in Q1 2017 without material impact. It expects to adopt the new revenue standard in Q1 2018 using the full retrospective method; the impact remains under evaluation, including possible earlier recognition for certain shipping terms and contracts.
- Management reported disclosure controls were effective at the reasonable-assurance level and no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether margin pressure persists, particularly in Public Sector and on large project rollouts, and whether growth in higher-margin services offsets product-mix effects.
- Whether receivables and inventory convert to cash as expected after the first-half working-capital outflow; monitor DSO, inventory levels, and payables.
- Execution and cost of planned IT and advanced-solutions investments, including the potential spending above $20 million.
- Outcome and potential financial exposure of the multi-state unclaimed-property audit.
- Final effects and transition adjustments from adopting the revenue recognition standard in 2018.
- Compliance with credit-facility covenants and continued availability of borrowing capacity if cash generation or Adjusted EBITDA weakens.