PC Connection, Inc. — FY 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing also reports unaudited fourth-quarter results. PC Connection (Nasdaq: CNXN) sells IT products and services through Business Solutions, Enterprise Solutions, and Public Sector Solutions.
Financial performance
| Metric | FY 2019 | FY 2018 | Change |
|---|---|---|---|
| Net sales | $2,820.0 million | $2,699.5 million | +4.5% |
| Gross profit / gross margin | $451.3 million / 16.0% | $411.1 million / 15.2% | Margin +0.8 percentage points |
| Operating income / margin | $112.0 million / 4.0% | $85.7 million / 3.2% | Operating income +30.7% |
| Net income | $82.1 million | $64.6 million | +27.1% |
| Diluted EPS | $3.10 | $2.41 | +$0.69 |
| Operating cash flow | $36.6 million | $86.8 million | Down $50.2 million |
- FY 2019 sales increased in all three segments: Public Sector +11.8% to $566.2 million; Business Solutions +3.1% to $1,060.0 million; Enterprise Solutions +2.5% to $1,193.8 million. Public Sector had the strongest growth.
- Gross margin improved in each segment: Business Solutions 19.1%, Enterprise Solutions 14.4%, and Public Sector Solutions 13.6%. Management attributed overall improvement mainly to higher invoice selling margins, software revenue presented net in certain agent transactions, and—in Public Sector—customer mix and hardware margins.
- SG&A rose 4.4% to $338.6 million, primarily from personnel and advertising costs, but remained 12.0% of sales. Restructuring charges were $0.7 million, versus $1.0 million in 2018.
- Fourth-quarter 2019 sales were $716.6 million and net income was $22.0 million; diluted EPS was $0.83. Fourth-quarter 2018 sales were $709.5 million and net income was $21.3 million; diluted EPS was $0.80.
- Cash and cash equivalents were $90.1 million at year-end, versus $91.7 million in 2018. Working capital was $467.5 million. Total assets were $937.3 million and stockholders’ equity was $597.3 million.
- No bank borrowings were outstanding at year-end; the full $50.0 million revolving line was available through February 2022, subject to covenants. Accounts payable were $235.6 million. Reported lease liabilities were $14.6 million, following adoption of lease accounting rules in 2019.
- Operating cash flow fell as accounts receivable grew $101.9 million; days sales outstanding increased to 63 from 52. Inventory rose $5.5 million, and inventory turns declined to 18 from 21. Capital expenditures for equipment and capitalized software were $25.7 million.
Material changes and comparability
- Net sales rose 4.5% in 2019 after declining 7.3% in 2018. The 2018 comparison with 2017 is materially affected by adoption of ASC 606: certain software, cloud, and service transactions shifted from gross to net revenue presentation. The company states that 2019 and 2018 sales are not directly comparable with 2017; net presentation generally reduces reported revenue and cost of sales without an equivalent reduction in gross profit.
- Net revenue recognized on a net basis for specified software sales was $521.7 million in 2019 and $396.7 million in 2018. Third-party services and agency sales recognized net were $51.0 million, $46.8 million, and $38.3 million in 2019, 2018, and 2017, respectively.
- Operating cash flow was substantially lower despite higher net income, principally reflecting the receivables increase and shipment timing. This is a notable divergence between earnings growth and cash generation.
- ASC 842 adoption in 2019 added right-of-use assets and lease liabilities; 2019 total assets are not directly comparable with prior years on that basis.
- 2018 other income included a $2.3 million net gain related to resolution of a contract dispute. 2019 other income was $0.7 million.
Outlook, risks, and contingencies
- Management said available cash, expected operating cash flow, and the credit line should fund working capital, capital expenditures, and other needs for at least the next 12 months. It expected the 2020 corporate income tax rate to be 27%–29%; no revenue or earnings guidance was provided.
- Management’s priorities include growing revenue and gross margins, improving sales and technical staff productivity, controlling SG&A, and investing in IT systems and higher-margin solutions. It cautioned that service-engineer costs could pressure results if service revenue does not grow sufficiently.
- Principal risks include intense price and competitive pressure; reduced vendor incentives or product availability; reliance on key distributors and HP products (HP Inc. and Hewlett Packard Enterprise products represented about 19% of 2019 sales); inventory obsolescence; weaker IT or government spending; evolving cloud/SaaS distribution; cybersecurity and systems disruption; and ability to collect receivables.
- The company identified $73.6 million of goodwill, primarily in Enterprise Solutions, as subject to impairment risk if performance or assumptions weaken. Its 2019 qualitative review found no impairment indication.
- Legal proceedings, including patent claims, were described as ordinary-course matters not expected by management to have a material effect. The company also noted possible exposure from tax, sales-tax, employment, and other audits; outcomes could be material. No quantified loss estimate is provided in the filing text.
- The 2019 special dividend was $0.32 per share, paid in January 2020. The company stated it had no current plans for additional dividends in the foreseeable future. It repurchased $4.5 million of shares during 2019, with $22.9 million of authorization remaining.
Important facts for investors to verify
- Whether the sharp rise in days sales outstanding and the $101.9 million receivables increase reversed through subsequent collections, and how operating cash flow develops.
- How much sales and margin growth is attributable to underlying demand versus ASC 606 net presentation, agency fees, product mix, and the Windows 7-related PC refresh.
- Whether gross-margin gains persist while the company increases spending on personnel, services, advertising, and IT infrastructure.
- Vendor concentration, especially the importance of HP products and dependence on Ingram Micro and Synnex, as well as any changes to supplier credit or incentives.
- Any subsequent changes to dividend or repurchase plans, liquidity, covenant headroom, goodwill assumptions, legal matters, or audit exposures.