PC Connection, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. PC Connection sells IT products and services through Business Solutions, Enterprise Solutions, and Public Sector Solutions.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $624.9 | $670.6 | Down 6.8% |
| Gross profit | $96.4 | $86.7 | Up 11.1% |
| Gross margin | 15.4% | 12.9% | Up 2.5 percentage points |
| SG&A | $80.9 | $75.3 | Up 7.4% |
| Operating income | $15.5 | $11.5 | Up 35.1% |
| Net income | $11.3 | $7.4 | Up 52.0% |
| Diluted EPS | $0.42 | $0.28 | Up $0.14 |
| Operating cash flow | $37.2 | $25.4 | Up $11.8 |
Higher gross profit reflected stronger invoice selling margins and greater sales of higher-margin advanced solutions. SG&A rose with variable compensation, advertising, and investment in solution selling. The effective tax rate declined to 27.5% from 35.2%, partly reflecting the lower federal corporate tax rate enacted in December 2017.
Segments and material comparisons
- Business Solutions: Sales were $263.3 million, down 3.8% as reported; segment operating income was $9.5 million versus $8.6 million.
- Enterprise Solutions: Sales were $257.2 million, up 1.7% as reported; segment operating income increased to $12.7 million from $9.1 million.
- Public Sector Solutions: Sales were $104.4 million, down 27.5%; segment operating loss widened to $3.1 million from $2.6 million. The prior-year period included a large federal desktop sale that did not recur, and sales to state/local government and higher education also declined.
The company adopted ASC 606 on January 1, 2018 using the modified retrospective method. Reported Q1 sales were reduced by net presentation of certain software and other transactions that were previously reported gross. Management says sales excluding the adoption effect would have been $700.5 million, up 4.5% year over year. The filing also reports a $1.2 million opening retained-earnings adjustment. ASC 606 affected timing and classification: the company’s reconciliation shows reported Q1 operating income of $15.5 million versus $15.0 million without adoption, and reported net income of $11.3 million versus $10.9 million without adoption. Comparative 2017 figures were not restated.
Cash, liquidity, and debt
- Cash and equivalents were $71.0 million at March 31, 2018, up from $50.0 million at December 31, 2017.
- Operating cash flow was $37.2 million; investing outflow was $5.0 million, primarily equipment and capitalized software purchases; financing outflow was $11.3 million, mainly a $9.1 million special dividend and $3.0 million of share repurchases.
- Current assets were $571.7 million and current liabilities were $193.6 million. Total stockholders’ equity was $492.0 million.
- Borrowings were $0.9 million under the $50.0 million receivables-backed credit facility, with $49.1 million available at quarter-end. The borrowing was repaid April 2, 2018. The facility expires in February 2022 and may be increased to $80.0 million for approved purposes. The company reported covenant compliance.
- Accounts receivable days sales outstanding were 53 days, versus 48 days a year earlier; management says DSO would have been 48 days excluding ASC 606. Inventory turns were 23 versus 25, or 26 versus 25 excluding the adoption effect.
Outlook, risks, and notable items
- No specific revenue or earnings guidance is provided. Management expects the 2018 corporate income tax rate to be 27%–29% and believes cash, operating cash generation, and available credit will fund requirements for at least the next 12 months.
- Expected capital expenditures for the next 12 months are $18–$20 million. The multi-year IT upgrade began in October 2017; $6.6 million had been spent through March 31, 2018, with an additional $12–$14 million expected over the next 18 months. Management also anticipates at least $0.1 million of quarterly third-party upgrade expenses for the next six quarters.
- Management highlights technology change and inventory obsolescence, supplier dependence and direct-selling competition, product availability, pricing pressure, economic and IT spending conditions, and the need to recruit and retain sales and technical staff. It cautions that service-engineer investment may weigh on results if service revenue does not grow sufficiently.
- Ordinary-course legal matters, including patent claims, are not expected by management to have a material effect. State audits and other tax, employment, and assessment matters could result in additional liabilities with a potentially material adverse effect.
- The company repurchased 116,241 shares in March for approximately $3.0 million under its $30 million repurchase authorization. It paid a special dividend of $0.34 per share in the quarter.
- Management concluded disclosure controls were effective at the reasonable-assurance level. Controls were modified for implementation of ASC 606; no other material control change was reported.
Important facts for investors to verify
- How much of underlying growth and margin improvement persists after separating ASC 606’s gross-to-net presentation and timing effects.
- Whether Public Sector Solutions stabilizes after the prior-year federal sale comparison and current weakness in government and education demand.
- Whether higher gross margins can be sustained while SG&A, solution-selling investment, and IT-upgrade spending increase.
- Receivables collection trends and cash conversion, including the reported increase in DSO and its accounting-standard adjustment.
- Progress and returns from the planned IT investment, and continued compliance with credit-facility covenants.