PC Connection, Inc. — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports unaudited quarterly results, including Q4 2017. Dollar amounts below are U.S. dollars.
Business context
PC Connection is a national IT products and solutions reseller serving small and medium-sized businesses, large enterprises, and public-sector and education customers through three segments. It sells hardware, software, and services through sales representatives and e-commerce. No individual customer contributed more than 3% of annual sales; HP products represented 20% of sales.
Key financial metrics
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Net sales | $2,911.9 million | $2,692.6 million |
| Gross profit / gross margin | $382.1 million / 13.1% | $371.2 million / 13.8% |
| Operating income / margin | $77.5 million / 2.7% | $80.5 million / 3.0% |
| Net income | $54.9 million | $48.1 million |
| Diluted earnings per share | $2.04 | $1.80 |
| Cash from operating activities | $19.3 million | $33.6 million |
| Cash and cash equivalents at year-end | $50.0 million | $49.2 million |
| Working capital at year-end | $368.1 million | $328.9 million |
| Total stockholders’ equity at year-end | $482.3 million | $433.4 million |
There were no bank borrowings at year-end. The company had a $50 million revolving credit facility available, expiring in February 2022, and reported $194.3 million in accounts payable. Capital expenditures were $11.8 million; operating cash flow less equipment purchases was approximately $7.5 million.
Material changes versus the prior comparable period
- Sales grew 8.1%, with increases in all three segments. Enterprise Solutions grew fastest, up 11.8%; Business Solutions rose 6.2% and Public Sector Solutions 5.4%.
- Gross profit increased 2.9%, but gross margin declined 0.7 percentage points to 13.1%, primarily amid intensified competition. Segment gross margins fell across all three businesses.
- SG&A increased 4.8% to $304.5 million, including investment in solution-sales personnel, acquisition-related costs, and a $1.3 million one-time employee bonus. Operating income consequently declined 3.7%.
- Net income rose 14.0% despite lower operating income, mainly because the effective tax rate fell to 29.3% from 40.2%. The 2017 tax provision included an estimated $7.8 million benefit from remeasuring deferred tax liabilities after U.S. tax reform.
- Operating cash flow fell to $19.3 million, partly reflecting a $39.5 million cash use from receivables and a $16.2 million increase in inventory, partly offset by higher payables. Receivables rose $37.8 million year over year; days sales outstanding remained 48, while inventory days increased from 13 to 15.
- Public Sector Solutions operating income dropped to $1.0 million from $8.6 million, while Enterprise Solutions operating income increased to $50.2 million from $42.5 million.
In Q4, sales were $762.3 million versus $735.5 million a year earlier, and net income was $20.7 million versus $13.0 million. Q4 net income benefited from the tax remeasurement; the quarter’s tax provision was $1.3 million.
Outlook, commentary, risks, and unusual items
- Management expects a 2018 corporate income tax rate of 27%–29%. It did not provide a specific revenue or earnings forecast.
- Expected capital expenditures for the next 12 months were $18–$20 million. A multi-year IT infrastructure upgrade, begun in October 2017, is expected to require $15–$18 million over two years and to finish around mid-2019.
- Management said it expects cash, operating cash flow, and available credit to meet needs for at least the next 12 months. The 2017 special dividend of $0.34 per share, totaling $9.1 million, was paid in January 2018; the company said it had no current plans for further dividends.
- The 2018 adoption of the new revenue standard was expected to move recognition earlier for certain FOB-shipping-point hardware sales and to present certain software revenue, including SaaS and security software, net. The latter is expected to reduce both reported sales and cost of sales without changing gross profit; the final quantitative impact was not yet determined.
- Principal risks include intense price competition and margin pressure, rapid technology changes and inventory obsolescence, reliance on major vendors and vendor incentives, direct vendor sales and changing cloud/SaaS distribution, cybersecurity or systems disruption, and economic or government-spending weakness. The five largest vendors supplied 61% of product purchases; Ingram Micro accounted for 22% and HP for 11%.
- Unclaimed-property accruals were $0.9 million, and a multi-state audit remained in process. State tax and other audits could result in additional liabilities; management said ordinary-course legal claims were not expected to have a material effect. The company also leases facilities from entities related to its principal stockholders.
- Patricia Gallup and David Hall controlled approximately 55% of outstanding shares. Deloitte & Touche issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- Whether sales growth can continue while recovering gross margin and operating income, especially in Public Sector Solutions.
- Whether working-capital growth, particularly receivables and inventory, converts into stronger operating cash flow.
- The final accounting and comparability effects of the new revenue standard, including its impact on reported sales.
- Whether the estimated tax benefit and 2018 tax-rate outlook are consistent with subsequent tax disclosures and cash taxes.
- Progress, spending, and expected benefits from the IT upgrade, along with vendor concentration and HP supply exposure.
- Developments in the unclaimed-property and other tax audits, and any changes to dividends or credit-facility availability.