PC Connection, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. PC Connection is an IT solutions reseller serving SMB, large-account, and public-sector customers. Results are unaudited; amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $676.2 million | $627.6 million | $1,248.6 million | $1,208.9 million |
| Gross profit | $93.9 million | $83.0 million | $176.1 million | $160.6 million |
| Gross margin | 13.9% | 13.2% | 14.1% | 13.3% |
| Operating income | $21.0 million | $19.6 million | $36.2 million | $33.8 million |
| Net income | $12.5 million | $11.6 million | $21.5 million | $20.2 million |
| Diluted EPS | $0.47 | $0.44 | $0.81 | $0.76 |
Q2 sales rose 7.7% year over year and first-half sales rose 3.3%. Operating margin was 3.1% in Q2 versus 3.1% a year earlier, and 2.9% for the first half versus 2.8%. SG&A increased to $72.9 million in Q2 and $139.9 million for the first half; management attributed the increase to variable compensation, solution-sales investments, advertising, and Softmart costs. Effective tax rates were 40.7% for Q2 and 40.5% for the first half.
Segments and drivers
- Q2 SMB sales increased 8.3% to $280.8 million; Large Account sales increased 12.0% to $259.6 million. Public Sector sales decreased 0.6% to $135.7 million, reflecting lower federal-contract sales.
- For the first half, SMB sales rose 6.4% to $542.1 million and Large Account sales rose 4.2% to $459.7 million; Public Sector sales fell 4.5% to $246.8 million.
- Software represented 22% of Q2 sales versus 18% a year earlier. Management cited software, mobility, and higher-margin product mix as contributors to growth and improved gross margins. Public Sector gross margin improved despite lower sales.
Cash, liquidity, and capital
First-half operating cash flow was $17.0 million versus $16.5 million. Investing cash outflow was $39.8 million, primarily reflecting the Softmart purchase; financing cash outflow was $10.1 million, including a $10.6 million special dividend of $0.40 per share. Cash declined $32.9 million to $47.3 million from $80.2 million at year-end 2015.
At June 30, cash was $47.3 million, accounts receivable $388.0 million, inventory $112.5 million, current assets $555.2 million, and current liabilities $238.5 million. The company reported no bank borrowings and had the full $50 million receivables-backed facility available; it expires February 24, 2017 and may be increased to $80 million for approved uses. The facility is subject to covenants. Accounts payable included $34.6 million under supplier-supported inventory trade-credit arrangements, which are secured by inventory and bear no interest or discount fee payable by the company. Total liabilities were $255.1 million; the filing reports no other outstanding bank debt.
Material changes, outlook, and risks
- Softmart acquisition: Acquired substantially all assets on May 27, 2016 for $34.0 million, including $4.2 million held in escrow pending a working-capital adjustment. The preliminary allocation included $16.2 million of tax-deductible goodwill and $11.3 million of customer relationships. Softmart results are included in SMB from the acquisition date; the purchase-price allocation remained subject to refinement. Management said pro forma results were not presented because the acquisition’s effects were not material.
- Liquidity outlook: Management believes cash, operating cash generation, and available credit will cover requirements for at least the next 12 months. Expected next-12-month capital expenditures are $10–$12 million, with approximately $4 million of lease and other contractual-obligation payments. Potential IT infrastructure investment could exceed $20 million over the next two to four years; decisions were not finalized.
- Business risks: Management highlighted rapid technology change and inventory obsolescence, supplier availability and direct-sales efforts, competitive and pricing pressures, economic and IT-spending conditions, and the need to recruit and retain sales and technical staff. Higher service-personnel costs could pressure results if service revenue does not grow sufficiently. Receivables and inventory rose from year-end; DSO excluding Softmart increased to 45 days from 43 days a year earlier, and inventory turns declined to 22 from 24.
- Contingencies: Ordinary-course legal matters, including patent claims, were not expected by management to have a material effect. A multi-state unclaimed-property audit remained in progress; management said the ultimate outcome could not yet be determined and additional assessments could materially negatively affect results, financial position, or cash flows.
- Other disclosures: Management stated there were no material changes in market risk and no material change in internal control over financial reporting; disclosure controls were considered effective. No formal earnings or revenue guidance was provided. The company early-adopted deferred-tax balance-sheet classification guidance, with no income-statement impact.
Important facts for investors to verify
- Final Softmart working-capital adjustment and purchase-price allocation, and the acquisition’s subsequent contribution to SMB sales, margins, and cash generation.
- Whether higher receivables and inventory, longer DSO, and slower inventory turns reverse or continue, and the resulting effect on operating cash flow.
- Public Sector demand, particularly federal-contract sales, and whether growth in software and solution services offsets product and segment weakness.
- Progress and potential exposure from the unclaimed-property audit and other tax assessments.
- Timing and funding of planned capital expenditures and IT investment, along with renewal or replacement of the bank facility expiring in February 2017.