PC Connection, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with the three months ended March 31, 2016 unless noted. The unaudited consolidated statements cover PC Connection and subsidiaries. The company is an IT solutions reseller serving SMB, Large Account, and Public Sector customers.
Financial results
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $670.6 million | $572.4 million | +17.2% |
| Gross profit | $86.7 million | $82.2 million | +5.5% |
| Gross margin | 12.9% | 14.4% | Down 1.5 percentage points |
| SG&A | $75.3 million | $67.0 million | +12.4%; 11.2% vs. 11.7% of sales |
| Operating income | $11.5 million | $15.2 million | Down 24.5%; 1.7% vs. 2.7% of sales |
| Net income | $7.4 million | $9.1 million | Down 18.0% |
| Diluted EPS | $0.28 | $0.34 | Down $0.06 |
| Operating cash flow | $25.4 million | $23.5 million | Up $2.0 million |
At March 31, 2017, cash was $65.8 million, versus $49.2 million at December 31, 2016. Current assets were $550.7 million and current liabilities $211.5 million. Accounts receivable was $378.5 million and inventory $100.0 million. Days sales outstanding rose to 48 days from 41 days in the prior-year quarter; inventory turns increased to 25 from 19.
Cash used in investing was $1.5 million, primarily property and equipment purchases; cash used in financing was $7.4 million. The company paid a $9.0 million special dividend ($0.34 per share) and received $1.7 million from stock option exercises. Cash increased $16.6 million during the quarter.
No bank borrowings were outstanding. The company had a $50.0 million receivables-backed credit facility available, with an option to increase it to $80.0 million for approved uses. Separately, $24.2 million of accounts payable was due under supplier-supported inventory financing arrangements. Stockholders’ equity was $442.7 million.
Material changes and management commentary
- Revenue growth reflected increases in all three segments. Softmart, acquired in May 2016, contributed $28.0 million to the year-over-year sales increase. Large Account sales grew 26.4%, Public Sector 29.7%, and SMB 4.7%.
- Large Account growth benefited from large project rollouts; Public Sector growth included a federal project rollout. Management cited higher software, mobility, and networking product sales, along with investments in advanced-solution sales.
- Margins declined across all segments. Public Sector gross margin fell to 9.2% from 12.8%, principally due to lower-margin desktop and notebook mix on a large federal rollout. Large Account and SMB margins also weakened from product/client mix and lower-margin sales.
- SG&A rose in dollars, including higher personnel costs and investments in sales, technical, and engineering resources, but declined as a share of revenue. Lower gross margins and higher SG&A drove lower operating and net income.
- The effective tax rate was 35.2%, versus 40.2%, partly reflecting a $656,000 discrete tax benefit from stock-based compensation under newly adopted share-based payment accounting guidance.
Outlook, risks, and unusual items
- Management expects cash from operations and available credit to cover working capital, capital expenditures, and other requirements for at least the next 12 months. Expected next-12-month capital expenditures are $10–$12 million; lease and other contractual payments are approximately $5 million.
- The company is evaluating IT infrastructure investments; a fully implemented project could entail incremental capital costs exceeding $20 million over the next one to three years. Management expects infrastructure investment to increase in that period, with potential additional depreciation and SG&A.
- Management is expanding advanced-solution capabilities but cautioned that hiring skilled engineers increases costs and results could decline if related revenue does not grow sufficiently. The filing provides no specific revenue or earnings guidance.
- Key risks include rapid technology change and inventory obsolescence, supplier direct-sales efforts and product availability, competitive and pricing pressure, economic conditions and IT spending, and execution of IT and salesforce investments.
- A multi-state unclaimed-property audit remains in progress. Management believes known and estimated liabilities are adequately provided, but says additional assessments could have a material adverse effect; the ultimate outcome is not yet determinable. Other legal matters, including patent claims, are not expected by management to be material.
- The company expects to adopt the new revenue recognition standard in Q1 2018 using the full retrospective method. It was still assessing the impact, including whether revenue on certain products warehoused for later customer deployment could be recognized earlier. Adoption of the inventory measurement standard had no material impact.
Important facts for investors to verify
- Whether project-driven sales growth, particularly in Large Account and Public Sector, is repeatable and can be sustained without further margin pressure.
- Whether gross margins recover, especially in Public Sector, and whether advanced-solution revenue offsets added personnel and technology costs.
- Receivables collection and inventory trends, including the increase in days sales outstanding and inventory tied to in-transit customer deployments.
- The outcome of the unclaimed-property audit and any resulting assessments.
- The eventual financial-statement and disclosure effects of revenue-standard adoption and the scale and timing of planned IT investments.
- Credit-facility covenant compliance and liquidity assumptions; management reported compliance and no bank borrowings at quarter-end.