PC CONNECTION INC - Quarter Report: 2017 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☑QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934*

For the quarterly period ended September 30, 2017

OR

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number 0-23827

PC CONNECTION, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

Former name, former address and former fiscal year, if changed since last report: N/A

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  ☑    NO  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES  ☑    NO  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  ☐    NO  ☑

The number of shares outstanding of the issuer’s common stock as of November 3, 2017 was 26,815,634.

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS  

(Unaudited)

(amounts in thousands)

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

PART I―FINANCIAL INFORMATION

Item 1―Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF INCOME  

(Unaudited)

(amounts in thousands, except per share data)

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

PART I―FINANCIAL INFORMATION

Item 1―Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  

(Unaudited)

(amounts in thousands)

 

 

 

 

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

PART I―FINANCIAL INFORMATION

Item 1―Financial Statements

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  

(amounts in thousands, except per share data)

Note 1–Basis of Presentation

 

The accompanying condensed consolidated financial statements of PC Connection, Inc. and its subsidiaries (the “Company,” “we,” “us,” or “our”) have been prepared in accordance with accounting principles generally accepted in the United States of America.  Such principles were applied on a basis consistent with the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (the “SEC”).  The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements contained in our Annual Report on Form 10-K.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results of operations for the interim periods reported and of the Company’s financial condition as of the date of the interim balance sheet.  The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure.  Subsequent events have been evaluated through the date of issuance of these financial statements.  The operating results for the three and nine months ended September 30, 2017 may not be indicative of the results expected for any succeeding quarter or the entire year ending December 31, 2017.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions.  These estimates and assumptions affect the amounts reported in the accompanying condensed consolidated financial statements.  Actual results could differ from those estimates.

 

Comprehensive Income

 

We had no items of comprehensive income, other than our net income for each of the periods presented.

 

Recently Issued Financial Accounting Standards

 

On May 28, 2014, the Financial Accounting Standards Board, or the FASB, issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which amends the existing accounting standards for revenue recognition. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB voted to amend ASU 2014-09 by approving a one-year deferral of the mandatory effective date as well as providing the option to early adopt the standard on the original effective date. Accordingly, the Company will adopt the standard in its first quarter of 2018. An entity may choose to adopt the new standard either through a full retrospective method with application to all periods presented or on a modified retrospective method through a cumulative effect adjustment as of the start of the first period for which it applies the new standard. We are in the process of determining the effect that the adoption will have on our consolidated financial statements. Based on our analysis to date, we have reached the following tentative conclusions regarding the new standard and how we expect it to affect our consolidated financial statements and related disclosures:

 

 

 

 

 

 

 

Our analysis and evaluation of the new standard will continue through its effective date in the first quarter of 2018. A substantial amount of work remains to be completed due to the complexity of the new standard, the application of judgment, and the requirement for the use of estimates in applying the new standard, as well as the volume of our client portfolio and the related terms and conditions of our contracts that must be reviewed.

 

In February 2016, the FASB issued ASU 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than twelve months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently assessing the potential impact of the adoption of ASU 2016-02 on our consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the accounting for goodwill impairments by eliminating step two from the goodwill impairment test.  Instead, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.  ASU 2017-04 also clarifies the requirements for excluding and allocating foreign currency translation adjustments to reporting units related to an entity's testing of reporting units for goodwill impairment and clarifies that an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable.  ASU 2017-04 is effective for us beginning January 1, 2020 for both interim and annual reporting periods.  We are currently assessing the potential impact of the adoption of ASC 2017-04 on our consolidated financial statements.

 

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, which modifies existing requirements regarding measuring inventory at the lower of cost or market. Under prior standards, the market amount required consideration of replacement cost, net realizable value (NRV), and NRV less an approximately normal profit margin. The new ASU replaces market with NRV, defined as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This eliminates the need to determine and consider replacement cost or NRV less an approximately normal profit margin when measuring inventory. We adopted the standard in the first quarter of 2017 and applied the provisions prospectively. The adoption of ASU 2015-11 did not have a material impact on our consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The new standard simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under this guidance, a company recognizes all excess tax benefits and tax deficiencies as

income tax expense or benefit in the income statement. This change eliminates the notion of the additional paid-in capital pool and reduces the complexity in accounting for excess tax benefits and tax deficiencies. The primary impact of our adoption was the recognition of excess tax benefits related to equity compensation in our provision for income taxes rather than paid-in capital, which is a change required to be applied on a prospective basis in accordance with the new guidance. There were no unrecognized excess tax benefits at implementation.  Accordingly, we recorded discrete income tax benefits in the consolidated statements of income of $995 during the nine months ended September 30, 2017, for excess tax benefits related to equity compensation. The corresponding cash flows are reflected in cash provided by operating activities instead of financing activities, as was previously required.  We adopted the cash flow presentation that requires presentation of excess tax benefits within operating activities on a prospective basis. Additionally, under ASU 2016-09, we have elected to continue to estimate equity award forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. Additional amendments to the accounting for income taxes and minimum statutory withholding tax requirements had no impact on our results of operations. The presentation requirements for cash flows related to employee taxes paid for withheld shares also had no impact to any of the periods presented in our condensed consolidated statements of cash flows since such cash flows have historically been presented as a financing activity.    

 

Note 2–Earnings Per Share

 

Basic earnings per common share is computed using the weighted average number of shares outstanding.  Diluted earnings per share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributable to nonvested stock units and stock options outstanding, if dilutive.

 

The following table sets forth the computation of basic and diluted earnings per share:

 

 

For the three and nine months ended September 30, 2017 and 2016, the following outstanding nonvested stock units were excluded from the computation of diluted earnings per share because including them would have had an anti-dilutive effect:

 

 

 

 

Note 3–Acquisitions

 

Softmart Acquisition

 

On May 27, 2016, we acquired substantially all of the assets of Softmart Inc. (“Softmart”), a global supplier of information technology and software services solutions.  The purchase of Softmart is consistent with our strategy to expand our software services capabilities.  Under the terms of the asset purchase agreement, we paid $31,889, net of cash acquired, and allocated the total purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition.  The excess of the purchase price over the net assets acquired represents potential synergies from Softmart’s customer base and its assembled workforce of sales representatives and software service specialists that we acquired in the transaction.  This excess of purchase price over the aggregate fair values was recorded as goodwill.  We incurred $357 of transaction costs in 2016 related to the

acquisition which we reported in selling, general and administrative expenses, or SG&A, in our consolidated statement of income for the year ended December 31, 2016.  The operating results of Softmart have been included in the SMB and Large Accounts segments.  The revenues and income from operations of Softmart were not material to our consolidated results, and accordingly, we have not presented Softmart’s revenues or operating results on a pro forma basis.

 

The following table reflects components of the net assets acquired and liabilities assumed at fair value as of the closing date. 

 

 

We recorded goodwill of $7,366 and $6,948 in our SMB and Large Account segments, respectively, and the aggregate is expected to be fully deductible for tax purposes. 

 

GlobalServe Acquisition

 

On October 11, 2016, we acquired the outstanding common shares of GlobalServe, Inc. (“GlobalServe”), which has developed an internet portal tool that simplifies customers’ global IT procurement.  Under the terms of the stock purchase agreement, we paid $11,101, net of cash acquired.  The purchase of GlobalServe allows us to service our customers’ global IT needs through their OneSource internet portal with consistent delivery, reporting, pricing, and logistics.  We allocated the total purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition and recorded the excess of purchase price over the aggregate fair values as goodwill.  In 2016 we incurred $118 of transaction costs related to the acquisition which we reported in SG&A expenses in our consolidated statement of income for the year ended December 31, 2016.  We have included the operating results of GlobalServe in the Large Account segment since the acquisition date.  The revenues and income from operations of GlobalServe were not material to our consolidated results, and accordingly, we have not presented GlobalServe’s revenues or operating results on a pro forma basis.

 

The following table reflects components of the net assets acquired and liabilities assumed at fair value as of the closing date.   

 

 

We recorded $8,012 of goodwill as a result of our acquisition of GlobalServe in our Large Account segment.  None of the goodwill related to this acquisition will be deductible for tax purposes. 

 

 

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Note 4–Segment and Related Disclosures

 

The internal reporting structure used by our chief operating decision maker (“CODM”) to assess performance and allocate resources determines the basis for our reportable operating segments.  Our CODM is our Chief Executive Officer, and he evaluates operations and allocates resources based on a measure of operating income.

 

Our operations are organized under three reportable segments—the SMB segment, which serves primarily small- and medium-sized businesses; the Large Account segment, which serves primarily medium-to-large corporations; and the Public Sector segment, which serves primarily federal, state, and local governmental and educational institutions.  In addition, the Headquarters/Other group provides services in areas such as finance, human resources, information technology, marketing, and product management.  Most of the operating costs associated with the Headquarters/Other group functions are charged to the operating segments based on their estimated usage of the underlying functions.  We report these charges to the operating segments as “Allocations.”  Certain headquarters costs relating to executive oversight and other fiduciary functions that are not allocated to the operating segments are included under the heading of Headquarters/Other in the tables below.

 

In May 2016, we acquired Softmart.  As initially reported in our third quarter results for 2016, the operating results of Softmart were included in the SMB segment.  This segment allocation was revised in our results for the year as reported in our 2016 10-K.  Under this revised reporting, the operating results of Softmart that were initially included in the SMB segment are now allocated between the SMB and Large Account segments and continue to be allocated between these two segments.   

 

In October 2016, we acquired GlobalServe.  We have included the operating results for GlobalServe in our Large Account segment.  The external sales and operating results of GlobalServe were immaterial to our consolidated results. 

   

Segment information applicable to our reportable operating segments for the three and nine months ended September 30, 2017 and 2016 is shown below:

 

 

The assets of our three operating segments presented above consist primarily of accounts receivable, intercompany receivable, goodwill, and other intangibles.  Assets reported under the Headquarters/Other group are managed by corporate headquarters, including cash, inventory, and property and equipment.  Total assets for the Headquarters/Other group are presented net of intercompany balance eliminations of $16,728 as of September 30, 2017.  Our capital expenditures consist largely of IT hardware and software purchased to maintain or upgrade our management information systems.  These information systems serve all of our segments, to varying degrees, and accordingly, our CODM does not evaluate capital expenditures on a segment basis.

 

Note 5–Commitments and Contingencies

 

We are subject to various legal proceedings and claims, including patent infringement claims, which have arisen during the ordinary course of business.  In the opinion of management, the outcome of such matters is not expected to have a material effect on our financial position, results of operations, and cash flows.

 

We are subject to audits by states on sales and income taxes, employment matters, and other assessments.    Additional liabilities for these and other audits could be assessed, and such outcomes could have a material, negative impact on our financial position, results of operations, and cash flows.

 

Note 6–Bank Borrowing

 

We have a $50,000 credit facility collateralized by our accounts receivable that expires February 10, 2022.  This facility can be increased, at our option, to $80,000 for approved acquisitions or other uses authorized by the lender on substantially the same terms.  Amounts outstanding under this facility bear interest at the one-month London Interbank Offered Rate, or LIBOR, plus a spread based on our funded debt ratio, or in the absence of LIBOR, the prime rate (4.25% at September 30, 2017).  The one-month LIBOR rate at September 30, 2017 was 1.23%.  The credit facility includes various customary financial ratios and operating covenants, including minimum net worth and maximum funded debt ratio requirements, and default acceleration provisions.  The credit facility does not include restrictions on future dividend payments.  Funded debt ratio is the ratio of average outstanding advances under the credit facility to Adjusted EBITDA (Earnings Before Interest Expense, Taxes, Depreciation, Amortization, and Special Charges).  The maximum allowable funded debt ratio under the agreement is 2.0 to 1.0.  Decreases in our consolidated Adjusted EBITDA could limit our potential borrowings under the credit facility.  We had no outstanding bank borrowings at September 30, 2017 or December 31, 2016, and accordingly, the entire $50,000 facility was available for borrowings under the credit facility.

 

 

 

 

 

 

PC CONNECTION, INC. AND SUBSIDIARIES

PART I―FINANCIAL INFORMATION

Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

 

Statements contained or incorporated by reference in this Quarterly Report on Form 10‑Q that are not based on historical fact are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act.  These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of management including, without limitation, our expectations with regard to the industry’s rapid technological change and exposure to inventory obsolescence, availability and allocations of goods, reliance on vendor support and relationships, competitive risks, pricing risks, and the overall level of economic activity and the level of business investment in information technology products. Forward-looking statements may be identified by the use of forward-looking terminology such as “may,” “could,” “expect,” “believe,” “estimate,” “anticipate,” “continue,” “seek,” “plan,” “intend,” or similar terms, variations of such terms, or the negative of those terms.

 

We cannot assure investors that our assumptions and expectations will prove to have been correct.  Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict.  These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements.  We therefore caution you against undue reliance on any of these forward-looking statements.  Important factors that could cause our actual results to differ materially from those indicated or implied by forward-looking statements include those discussed in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q and in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.  Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which this Quarterly Report on Form 10-Q was first filed.  We undertake no intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required by law.

 

OVERVIEW

 

We are a leading solutions provider of a wide range of information technology, or IT, solutions.  We help our customers design, enable, manage, and service their IT environments. We provide IT products, including computer systems, software and peripheral equipment, networking communications, and other products and accessories that we purchase from manufacturers, distributors, and other suppliers.  We also offer services involving design, configuration, and implementation of IT solutions.  These services are performed by our personnel and by third-party service providers.  We operate through three sales segments, which serve primarily: (a) small- to medium-sized businesses, or SMBs, through our PC Connection Sales subsidiary, (b) large enterprise customers, in our Large Account segment, through our MoreDirect subsidiary, and (c) federal, state, and local governmental and educational institutions, in our Public Sector segment, through our GovConnection subsidiary.

 

We generate sales primarily through outbound telemarketing and field sales contacts by account managers focused on the business, education, and government markets, our websites, and inbound calls from customers responding to our catalogs and other advertising media.  We seek to recruit, retain, and increase the productivity of our sales personnel through training, mentoring, financial incentives based on performance, and updating and streamlining our information systems to make our operations more efficient.

 

As a value added reseller in the IT supply chain, we do not manufacture IT hardware or software.  We are dependent on our suppliers—manufacturers and distributors that historically have sold only to resellers rather than directly to end users.  However, certain manufacturers have on multiple occasions attempted to sell directly to our customers, and in some cases, have restricted our ability to sell their products directly to certain customers, thereby attempting to eliminate our role.  We believe that the success of these direct sales efforts by suppliers will depend on their ability to meet our customers’ ongoing demands and provide objective, unbiased solutions to meet their needs.  We believe more of our customers are seeking comprehensive IT solutions, rather than simply the acquisition of specific IT products.  Our

advantage is our ability to be product-neutral and provide a broader combination of products, services, and advice tailored to customer needs.  By providing customers with customized solutions from a variety of manufacturers, we believe we can mitigate the negative impact of continued direct sales initiatives from individual manufacturers.  Through our Technology Solutions Group, we are able to provide customers complete IT solutions, from identifying their needs, to designing, developing, and managing the integration of products and services to implement their IT projects.  Such service offerings carry higher margins than traditional product sales.  Additionally, the technical certifications of our service engineers permit us to offer higher-end, more complex solutions that generally carry higher gross margins.  We expect these service offerings and technical certifications to continue to play a role in sales generation and improve gross margins in this competitive environment.

 

The primary challenges we continue to face in effectively managing our business are (1) increasing our revenues while at the same time improving our gross margin in all three segments, (2) recruiting, retaining, and improving the productivity of our sales personnel, and (3) effectively controlling our selling, general and administrative, or SG&A, expenses while making major investments in our IT systems and solution selling personnel, especially in relation to changing revenue levels.

 

To support future growth, we are expanding our IT solution business, which requires the addition of highly-skilled advanced solution engineers.  Although we expect to realize the ultimate benefit of higher-margin advanced solution services and product revenues under this multi-year initiative, we believe that our cost of sales may increase significantly as we add such engineers.  If our advanced solution revenues do not grow enough to offset the cost of these headcount additions, our operating results may decline.

 

Market conditions and technology advances significantly affect the demand for our products and services.  Virtual delivery of software products and advanced internet technology providing customers enhanced functionality have substantially increased customer expectations, requiring us to invest more heavily in our own IT development to meet these new demands.  This investment includes significant planned expenditures to update our websites, as buying trends change and electronic commerce continues to grow.

 

Our investments in IT infrastructure are designed to enable us to operate more efficiently and to provide our customers enhanced functionality.  In October 2017, we began a multi-year initiative to upgrade our IT infrastructure, and accordingly we expect to increase our related capital investments over the next two to three years.  This will also likely increase SG&A expenses as assets are placed into service and depreciated.

 

RESULTS OF OPERATIONS

 

The following table sets forth information derived from our statements of income expressed as a percentage of net sales for the periods indicated:

 

 

Net sales in the third quarter of 2017 increased year over year by $20.7 million, or 2.9%, compared to the third quarter of 2016, due to increased revenues in the Large Account and SMB sales segments.  Net sales of software and desktops grew year over year by 14% and 8%, respectively. SG&A expenses decreased year over year in dollars and as a percentage of net sales.  The decrease as a percentage of net sales was primarily due to higher net sales in the third quarter of 2017, compared to the prior year quarter.  Gross margin decreased due to a competitive demand environment and changes in vendor funding programs.  The decrease in SG&A expenses in dollars was primarily due to lower personnel costs due to lower gross profit and cost reductions implemented in the second quarter of 2017.  Operating income in the third quarter of 2017 decreased year over year in dollars and as a percentage of net sales compared to the prior year period due to lower gross profit.  Gross profit was adversely affected by lower invoice selling margins and lower vendor funding which reduces our cost of sales.

 

Net Sales Distribution

 

The following table sets forth our percentage of net sales by segment and product mix:

 

 

Gross Profit Margin

 

The following table summarizes our gross margin, as a percentage of net sales, over the periods indicated:

 

 

Operating Expenses

 

The following table reflects our SG&A expenses for the periods indicated (dollars in millions):

 

 

 

Year-Over-Year Comparisons

 

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

 

 

Changes in net sales and gross profit by segment are shown in the following table (dollars in millions):

 

 

Net sales increased in the third quarter of 2017 compared to the third quarter of 2016, as explained below:

 

 

 

 

Gross profit for the third quarter of 2017 decreased year over year in dollars and as a percentage of net sales (gross margin), as explained below: