PC Connection, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; financial statements are unaudited. PC Connection is an IT solutions reseller and services provider operating through Business Solutions, Enterprise Solutions, and Public Sector Solutions.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $729.4m | $658.5m | $2,103.4m | $1,990.0m |
| Gross profit | $118.9m | $100.4m | $335.2m | $304.3m |
| Gross margin | 16.3% | 15.3% | 15.9% | 15.3% |
| Operating income | $32.6m | $19.0m | $82.4m | $59.4m |
| Operating margin | 4.5% | 2.9% | 3.9% | 3.0% |
| Net income | $23.8m | $13.8m | $60.1m | $43.3m |
| Diluted EPS | $0.90 | $0.51 | $2.27 | $1.61 |
Cash and liquidity: Cash was $98.5m at September 30, 2019, versus $91.7m at December 31, 2018. Nine-month operating cash flow was $40.0m, down from $81.3m; investing cash outflow was $20.6m, mainly equipment and IT investments, and financing cash outflow was $12.6m. The company had no bank borrowings and $50.0m available on its receivables-backed credit facility, expiring February 2022. Total liabilities were $287.5m; the balance sheet includes $15.7m of operating lease liabilities. The filing reports no material off-balance-sheet arrangements.
Material changes and management commentary
- Q3 sales rose 10.8% year over year; nine-month sales increased 5.7%. Q3 growth came primarily from Business Solutions (+11.8%) and Public Sector Solutions (+19.7%); Enterprise Solutions rose 4.8%. For nine months, Public Sector grew 11.8%, Enterprise 5.8%, and Business 2.5%.
- Management attributed stronger results to higher sales and gross margins, including improved invoice margins, product/customer mix, and increased software sales reported net when the company acts as agent. It cited Windows 7 end-of-support-driven PC refresh demand and technology upgrades as sales contributors; timing of large customer rollouts weighed on some product categories.
- SG&A increased 5.8% in Q3 and 2.9% for the nine months, but declined as a share of sales. Q3 operating income grew faster than sales as gross profit growth outpaced expense growth.
- Receivables increased $31.4m and inventory $6.9m from year-end, contributing to lower operating cash flow. Days sales outstanding rose to 52 from 50 a year earlier; inventory turns fell to 16 from 22, which management linked chiefly to committed customer orders not yet shipped.
- Capital expenditures were $20.6m for the nine months, versus $15.6m a year earlier, primarily for IT infrastructure. Financing outflows included an $8.5m special dividend ($0.32 per share) and $4.4m of treasury-share repurchases.
Outlook, risks, and unusual items
- Management expects the 2019 corporate income tax rate to be 27%–29%. It believes cash, operating cash generation, and available credit will cover working capital, capital expenditures, and other needs for at least 12 months; no formal revenue or earnings guidance is provided.
- Management noted risks from economic activity and IT spending, competition and suppliers selling directly to customers, product availability and allocations, pricing pressure, rapid technology change and inventory obsolescence, and the need to recruit and retain sales and technical staff. Investment in service engineers and IT systems may pressure results if related revenue growth is insufficient.
- The company recorded $0.7m of first-quarter restructuring charges for workforce reductions and closure of an office; all planned costs were incurred by March 31, and no ongoing restructuring plan was reported.
- ASC 842 lease accounting adoption in January 2019 recognized a right-of-use asset and lease liability; September 30 balances were $14.9m and $15.7m, respectively. Related-party leases accounted for $6.0m of the ROU asset and $5.0m of lease liability.
- Management said ordinary-course legal proceedings, including patent claims, were not expected to have a material effect. State tax, employment, and other audits could result in additional liabilities that could materially affect results or cash flows. No additional risk factors were identified for the quarter.
Important facts for investors to verify
- Whether margin gains and strong Q3 growth are sustainable, particularly given product-rollout timing and software revenue reported net as agent.
- Whether receivables and inventory convert to cash as expected, and whether the deterioration in cash flow and inventory turns reverses.
- Whether IT investment and service-engineer costs produce the higher-margin service growth management anticipates.
- Potential exposure from tax and other audits, and the effect of related-party leases and lease commitments.
- Credit-facility covenant headroom: the company reported $50.0m available, no borrowings, and equity of $583.1m versus a stated minimum-net-worth requirement of $443.0m.