What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-08-10 compared with 2020-04-30 · 196 added, 116 removed, 147 unchanged (68% of the section changed)

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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.

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.

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, including the effects of the novel coronavirus (COVID-19) on our business, financial condition, and results of operations, 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.

These statements involve known and unknown risks, uncertainties and other factors, including the effects of the coronavirus pandemic (“COVID-19”) and successful integration of our new ERP system on our business, financial condition, and results of operations, 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, 2019.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in 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, 2019.

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.

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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 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

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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 and technical support 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 solutions business, which requires the addition of highly-skilled service engineers.

The primary challenges we continue to face in effectively managing our business, especially in the current economic environment, 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 and technical support 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 have expanded, and expect to continue to expand, our IT solutions business, which requires the addition of highly-skilled service engineers.

Although we expect to realize the ultimate benefit of higher-margin service revenues under this multi-year initiative, we believe that our cost of services will increase as we add service engineers.

If our service revenues do not grow enough to offset the cost of these headcount additions, our operating results may be negatively impacted.

Market conditions and technology advances significantly affect the demand for our products and services.

Market and economic 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 on an ongoing basis in our own IT development to meet these new demands.

Our investments in IT infrastructure are designed to enable us to operate more efficiently and provide our customers enhanced functionality.

In the second quarter of 2020, we deployed a new Enterprise Resource Planning (“ERP”) system, which was the result of a multi-year planning and implementation process.

The implementation was substantially completed during the quarter, but required significant focus by key employees and management, as well as additional efforts by members of our sales team in certain circumstances, that adversely affected our second quarter execution and sales.

While we cannot quantify the adverse impact on our second quarter results, we believe the impact resulted in reduced potential incremental sales but did not result in any material cancelation of or inability to fulfill orders.

These additional efforts have continued in the third quarter, at successively decreasing levels, as we work toward complete integration with our business processes.

Ultimately, we expect the new ERP system to improve business performance by automating certain manual processes, standardizing business practices, and strengthening our internal financial controls.

EFFECTS OF COVID-19

In December 2019, a novel coronavirus disease (“COVID-19”) was reported, and in January 2020, the World Health Organization (“WHO”) declared it a Public Health Emergency of International Concern.

In December 2019, a novel coronavirus disease was reported, and in January 2020, the World Health Organization (“WHO”) declared it a Public Health Emergency of International Concern.

On February 28, 2020, the WHO raised its assessment of the COVID-19 threat from high to very high at a global level due to the continued increase in the number of cases and affected countries.

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We implemented remote work arrangements and restricted business travel in mid-March, but to date, these arrangements have not materially affected our ability to maintain our business operations, including the operation of financial reporting systems, internal controls over financial reporting, and disclosure controls and procedures.

We have also evaluated the potential impact of the pandemic on the carrying values of our goodwill and intangible assets, and based on our assessment, did not identify any indications to suggest that an impairment may exist.

The COVID-19 pandemic has resulted in material adverse economic conditions that are impacting, and may continue to impact, our business and the businesses of our suppliers and customers.

Although the extent and duration of the impact of the COVID-19 pandemic on our business and operations and the business and operations of our customers remains uncertain, the continued spread of COVID-19 and the imposition of related public health measures and restrictions may materially adversely impact our business, financial condition, results of operations and cash flows.

The COVID-19 pandemic has caused certain disruptions to our business and operations and could cause material disruptions to our business and operations in the future as a result of, among other things, quarantines, worker illness, worker absenteeism due to illness or other factors, social distancing measures and other travel, health-related, business or other restrictions.

We have also evaluated the potential impact of the pandemic on the carrying values

of our goodwill and intangible assets, and based on our assessment, did not identify any indications to suggest that an impairment may exist.

The COVID-19 pandemic has resulted in adverse economic conditions that are impacting, and may continue to impact, our business and the businesses of our suppliers and customers.

Although the extent and duration of the impact of the COVID-19 pandemic on our business and operations and the business and operations of our suppliers and customers remains uncertain, the continued spread of COVID-19 and the imposition of related public health measures and restrictions have and may continue to materially adversely impact our business, financial condition, results of operations and cash flows.

The COVID-19 pandemic has caused material disruptions to our business and operations and could cause further material disruptions to our business and operations in the future as a result of, among other things, quarantines, worker illness, worker absenteeism due to illness or other factors, social distancing measures and other travel, health-related, business or other restrictions.

For similar reasons, the COVID-19 pandemic has also adversely impacted, and may continue to adversely impact, our suppliers and their manufacturers.

Depending on the extent and duration of the previously-described effects on our business and the operations of our suppliers, our costs to obtain certain products could increase, our ability to obtain products or services from suppliers may be adversely impacted, our ability to service certain customers could be adversely impacted and, as a result, our business, financial condition and results of operations could be materially adversely affected.

In addition, the COVID-19 pandemic has caused, and may continue to cause, disruptions to the business and operations of our customers.

In addition, the COVID-19 pandemic has caused, and may continue to cause, material disruptions to the business and operations of our customers.

Certain of our customers have been, and may in the future be, required to close down or operate at a lower capacity, which may adversely impact our business, financial condition and results of operations.

In our opinion, customers who operate within the hospitality, airline, and retail industries, and in particular those within our Business Solutions Segment, are likely to be most adversely affected.

It is possible we could experience a decrease in orders as a result of the pandemic and there can be no assurances that any decrease in sales resulting from the COVID-19 pandemic will be offset by increased sales in the future.

We may also experience delays in collecting amounts owed to us, and in some cases, may experience inabilities to collect altogether.

As a result, we have increased our reserve against uncollectable amounts, which resulted in a significant increase in our operating expenses in the first quarter.

In our opinion, customers who operate within the hospitality, airline, and retail industries are likely to be most adversely affected.

We have experienced, and may continue to experience, decreases in orders as a result of the pandemic and there can be no assurances that any decrease in sales resulting from the COVID-19 pandemic will be met by increased sales in the future.

We also experienced, and may continue to experience, delays in collecting amounts owed to us, and in some cases, may experience inabilities to collect altogether.

As a result, we have increased our customer allowance for doubtful accounts by $3.3 million in the six months ended June 30, 2020 compared with the prior year.

As the effects of the COVID-19 pandemic continue to evolve, it is difficult to predict and forecast the impact it might have on our business and results of operations in the future.

However, we continue to monitor the effects on our customers, suppliers, and the economy as a whole and will adjust our business practices, as necessary, to respond to the changing demand for, and supply of, our products.

See the important information in Item 1A.

Risk Factors below, under the caption “The continued spread of COVID-19 and the imposition of related health measures and restrictions may materially adversely impact our business, financial condition, results of operations and cash flows.”

Risk Factors below, under the caption “The spread of COVID-19 and the imposition of related public health measures and restrictions have, and may in the future, further materially adversely impact our business, financial condition, results of operations and cash flows.”

RESULTS OF OPERATIONS

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Three Months Ended

Six Months Ended

Net sales (in millions)

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Income from operations

Net sales of $711.9 million for the first quarter of 2020 reflected an increase of $79.0 million compared to the first quarter of 2019, which was driven by growth in our Enterprise Solutions and Business Solutions segments.

Our ability to meet the continued demand for the personal computer refresh, and to supply customers with the necessary technology to implement work-from-home strategies and assist on the front lines of the COVID-19 pandemic fight led to increased sales of mobility, desktop, and net/com products.

We also saw significant increases in accessory products, which were driven by large project rollouts in the current period.

Gross profit dollars increased year-over-year by $13.9 million due to higher invoice selling margins realized on advanced solution sales, increased sales of both hardware and software products, and changes in customer mix.

SG&A expenses increased by $11.2 million, mostly due to higher personnel costs, and increased as a percentage of net sales.

Operating income in the first quarter of 2020 increased year-over-year both in dollars and as a percentage of net sales by $3.2 million and 15 basis points, respectively, primarily as a result of increased gross profit margins, which grew by 19 basis points over the period.

Net sales of $550.0 million for the second quarter of 2020 reflected a decrease of $191.1 million compared to the second quarter of 2019, which was driven by lower net sales across all of our business segments, primarily as a result of the decline in macroeconomic conditions due to the COVID-19 pandemic compared with the prior year.

While we continue to supply our customers with necessary technologies to implement work-from-home strategies, remote learning capabilities, and assist on the front lines of the COVID-19 pandemic fight, the impact of the shrinking economy over the

course of the second quarter was felt by customers across our business and caused a significant reduction in demand for our products.

Gross profit dollars decreased year-over-year by $28.0 million, primarily due to the decrease in net sales.

SG&A expenses decreased by $7.2 million, driven primarily by lower personnel costs associated with reduced headcount and lower variable compensation, along with lower product marketing expenses year-over-year.

These decreases were partially offset by increases in bad debt expense year-over-year resulting from anticipated collection challenges from customers who have been significantly impacted by the COVID-19 pandemic.

Also contributing to the offset were increased professional service fees resulting from the deployment of our new ERP system, which was largely completed in the second quarter of 2020.

Operating income in the second quarter of 2020 decreased year-over-year both in dollars and as a percentage of net sales by $21.7 million and 244 basis points, respectively, primarily as a result of the decrease in net sales.

Net Sales Distribution

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Three Months Ended

Six Months Ended

Sales Segment

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Three Months Ended

Six Months Ended

Sales Segment

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Three Months Ended

Six Months Ended

($ in millions)

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Facilities operations

Service contracts/subscriptions

Professional fees

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Percentage of net sales

(1) Operating expenses were separated into additional categories in 2020.

Certain prior-year balances have been classified to conform with the new presentation.

Restructuring and other charges

In the second quarter of 2020, we undertook a number of actions across our business to lower our cost structure and align our business in an effort to improve our ability to execute our strategy.

In connection with these restructuring initiatives, we incurred restructuring and other costs of $1.0 million in the second quarter of 2020, which were related to an involuntary reduction in workforce across our business segments and included cash severance and other related termination benefits.

These costs will be paid within a year of termination and any unpaid balances are included in accrued expenses at June 30, 2020.

There were no restructuring and other charges recorded in the second quarter of 2019.

Year-Over-Year Comparisons

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019

Changes in net sales and gross profit by segment are shown in the following table:

Three Months Ended March 31,

Three Months Ended June 30,

($ in millions)

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Public Sector Solutions

Net sales increased in the first quarter of 2020 compared to the first quarter of 2019, as explained below:

Net sales of $333.4 million for the Enterprise Solutions segment reflect an increase of $57.8 million, or 21.0%, year-over-year.

Accessory products, driven by orders associated with large project rollouts, increased by $34.5 million compared with the prior period.

Notebooks/mobility products grew by $12.8 million resulting from the tail end of the personal computer refresh due to the anticipated end-of-life support for Windows 7, and increased sales near the end of the quarter driven by workforces and consumers preparing to function remotely and increased demand from customers in the healthcare industry.

We also experienced increases in net/com products of $10.3 million.

Net sales of $278.8 million for the Business Solutions segment reflect an increase of $25.9 million, or 10.2% year-over-year.

Sales of notebooks/mobility products, desktop products, and other accessories increased by $10.7 million, $6.5 million, and $6.0 million, respectively.

These increases were primarily due to increased demand from customers at the end of the quarter for systems and accessories to support their workforces shifting to remote working capabilities and from customers in the healthcare industry, along with the remaining benefits from the personal computer refresh.

Net sales of software products also grew by $1.7 million year-over-year despite being negatively impacted by a higher percentage of our software sales recognized on a net basis in the current period in transactions where we are considered to be the agent.

Net sales decreased in the second quarter of 2020 compared to the second quarter of 2019, as explained below:

● Net sales of $246.8 million for the Enterprise Solutions segment reflect a decrease of $71.2 million, or 22.4%, year-over-year.

We experienced decreases in net sales across the majority of our product offerings primarily as a result of the deterioration in macroeconomic conditions in the second quarter of 2020.

The United States

economy shrank significantly period-over-period, the impact of which was felt by our customers and business partners and was reflected in our financial results.

Net sales of accessory products decreased by $26.9 million, primarily due to the change in macroeconomic conditions and the timing of large product rollouts.

We also experienced decreases in net sales of notebooks/mobility products, desktop products, other hardware/services, and software products of $17.1 million, $12.3 million, $11.4 million, and $10.9 million, respectively.

● Net sales of $191.1 million for the Business Solutions segment reflect a decrease of $80.0 million, or 29.5% year-over-year.

The Business Solutions Segment, which primarily serves the small- and medium-sized business sector, has been heavily impacted by the deterioration in macroeconomic conditions and drove the significant decrease in net sales year-over-year.

We experienced a decrease in net sales of desktop products of $20.3 million, notebooks/mobility products of $17.8 million, software products of $15.0 million, and net/com products of $8.6 million.

No other product category decreased by more than $6.7 million.

● Net sales of $112.2 million for the Public Sector Solutions segment decreased by $39.8 million, or 26.2%, compared with the same period a year ago.

We experienced decreases year-over-year in other hardware and services of $3.6 million, primarily as a result of some larger projects with the Federal government in the first quarter of the prior year that did not repeat in the current year quarter.

Net sales of software products also decreased by $2.0 million compared with the prior year and was negatively impacted by a higher percentage of our software sales recognized on a net basis in the current period in transactions where we are considered to be the agent.

These decreases in net sales were partially offset by increased sales of notebooks/mobility products of $1.6 million and displays and sound products of $1.6 million.

Gross profit for the first quarter of 2020 increased year-over-year in dollars and as a percentage of net sales (gross margin), as explained below:

Gross profit for the Enterprise Solutions segment increased primarily due to the 21.0% increase in net sales year-over-year, driven primarily by increases in net sales of net/com, accessory, and notebooks/mobility products, which grew by 70.5%, 61.0%, and 19.2%, respectively.

The change in gross margin in the quarter was driven by fluctuations in customer and hardware product mix.

Gross profit for the Business Solutions segment increased due to increased sales and higher invoice selling margins.

Invoice selling margins increased by 106 basis points primarily due to the increase in revenues reported on a net basis in the current year.

Gross profit for the Public Sector Solutions segment increased as a result of changes in customer mix and higher invoice selling margins of 181 basis points, driven primarily by improved hardware margins and an increase in software sales reported on a net basis.

Selling, general and administrative expenses increased in both dollars and as a percentage of net sales in the first quarter of 2020 compared to the prior year quarter.

The decrease in net sales was primarily driven by a deterioration in macroeconomic conditions and some larger projects with the federal government in the second quarter of 2019 that did not repeat in the current year.

Though we experienced decreases across the majority of our product lines, including software products of $12.5 million and servers/storage products of $12.1 million, net sales for notebooks and mobility products increased by $15.6 million year-over-year, which was primarily driven by orders by educational institutions preparing for and implementing remote learning capabilities.

Gross profit for the second quarter of 2020 decreased year-over-year in dollars, but increased as a percentage of net sales (gross margin), as explained below:

● Gross profit for the Enterprise Solutions segment decreased primarily as a result of the 22.4% decrease in net sales year-over-year.

Gross margin improved by 70 basis points in the current quarter, driven by fluctuations in customer and hardware product mix.

Gross margin for the quarter also benefitted from a higher percentage of our software sales in the current period being reported on a net basis.

● Gross profit for the Business Solutions segment decreased year-over-year due primarily to a 29.5% decrease in net sales, while gross margin remained relatively flat.

● Gross profit for the Public Sector Solutions segment decreased as a result of a 26.2% decrease in net sales.

Gross margin improved by 90 basis points year-over-year resulting from changes in customer mix, improved hardware margins, and as a result of a higher percentage of our software sales in the current period being reported on a net basis.

Selling, general and administrative expenses decreased in dollars, but increased as a percentage of net sales in the second quarter of 2020 compared to the prior year quarter.

SG&A expenses attributable to our three segments and the remaining unallocated Headquarters/Other group expenses are summarized in the table below:

Three Months Ended March 31,

Three Months Ended June 30,

($ in millions)

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Headquarters/Other, unallocated

SG&A expenses for the Enterprise Solutions segment increased in dollars, but decreased as a percentage of net sales.

The year-over-year change in SG&A dollars was attributable to increased personnel costs of $2.4 million, driven by merit increases and variable compensation associated with higher gross profit.

Bad debt expense increased by $0.8 million in the first quarter of 2020 compared with the prior year, primarily as a result of anticipated collection challenges from customers who have been significantly impacted by the COVID-19 pandemic.

The year-over-year increase in SG&A expense also resulted from a $0.4 million increase in the use of Headquarter services in the current period.

SG&A expenses as a percentage of net sales was 8.8% for the Enterprise Solutions segment in the first quarter of 2020, which reflects a decrease of 48 basis points and is a result of net sales growing at a higher rate than operating expenses when compared with the same period a year ago.

● SG&A expenses for the Enterprise Solutions segment decreased in dollars, but increased as a percentage of net sales.

The year-over-year change in SG&A dollars was attributable to decreased personnel costs of $2.3 million, driven primarily by a reduction in headcount and lower variable compensation expense associated with lower gross profit, along with lower product marketing and advertising expenses of $1.4 million.

These decreases were partially offset by increases of $0.2 million in the use of Headquarter services, including increased

contractor and consulting fees associated with the deployment of our new ERP system, and an increase of $0.2 million in bad debt expense, resulting from anticipated collection challenges from customers who have been significantly impacted by the COVID-19 pandemic.

SG&A expenses as a percentage of net sales was 9.6% for the Enterprise Solutions segment in the second quarter of 2020, which reflects an increase of 120 basis points and is a result of lower net sales in the quarter compared with the same period a year ago.

● SG&A expenses for the Business Solutions segment decreased in dollars and increased as a percentage of net sales.

The year-over-year change in SG&A dollars was attributable to decreased personnel costs of $1.7 million, driven primarily by a reduction in headcount and lower variable compensation expense associated with lower gross profit.

Also contributing to the decrease in the current quarter were lower product marketing and advertising expenses of $1.0 million and lower credit card fees of $0.3 million.

These decreases were partially offset by increases of $1.3 million in bad debt expense, resulting from anticipated collection challenges from customers who have been significantly impacted by the COVID-19 pandemic, and a $0.5 million increase in the use of Headquarter services, driven, in part, by increased contractor and consulting fees associated with the deployment of our new ERP system.

SG&A expenses as a percentage of net sales was 18.6% for the Business Solutions segment in the second quarter of 2020, which reflects an increase of 510 basis points and is a result of lower net sales in the quarter compared with the same period a year ago.

● SG&A expenses for the Public Sector Solutions segment decreased in dollars and increased as a percentage of net sales.

Personnel costs decreased by $1.6 million year-over-year, mainly due to a reduction in headcount and lower variable compensation associated with lower gross profit.

Partially offsetting the expense savings was an increase in the use of Headquarter services by $0.3 million period-over-period, which included increased contractor and consulting fees associated with the deployment of our new ERP system .

SG&A expenses as a percentage of net sales was 14.4% for the Public Sector Solutions segment in the second quarter of 2020, which reflects an increase of 300 basis points.

This increase year-over-year is primarily attributable to lower net sales in the quarter compared with the same period a year ago .

● SG&A expenses for the Headquarters/Other group decreased primarily resulting from a $2.0 million decrease in personnel-related costs driven primarily by a lower headcount and decreased variable compensation associated with lower gross profit.

Unallocated executive oversight costs also decreased by $1.0 million in the current period.

The Headquarters/Other group provides services to the three segments in areas such as finance, human resources, IT, marketing, and product management.

Most of the operating costs associated with such corporate Headquarters services are charged to the segments based on their estimated usage of the underlying services.

The amounts shown in the table above represent the remaining unallocated costs.

These decreases were partially offset by an increase in professional service fees of $1.1 million year-over-year, primarily driven by an increase in contractor and consulting fees arising from the deployment of our new ERP system in the second quarter of 2020.

Restructuring and other charges incurred in the second quarter of 2020 were $1.0 million and related to an involuntary reduction in workforce across our business segments, and included cash severance payments and other termination related benefits.

There were no such charges incurred in the second quarter of 2019.

Income from operations for the second quarter of 2020 decreased to $10.6 million, compared to $32.3 million for the second quarter of 2019, primarily due to the decreases in net sales and gross profit, along with lower SG&A expenses that decreased at a lower rate than net sales year-over-year.

Income from operations as a percentage of net sales was 1.9% for the second quarter of 2020, compared to 4.4% of net sales for the prior year quarter, primarily as a result of the decrease in net sales and increase in SG&A expenses.

Our effective tax rate was 27.9% for the second quarter of 2020, compared to 27.2% for the second quarter of 2019.

We expect our corporate income tax rate for 2020 to range from 26% to 28%.

Net income for the second quarter of 2020 decreased to $7.6 million, compared to $23.7 million for the second quarter of 2019, primarily due to lower net sales and gross profit, combined with an increase in operating expenses in the second quarter of 2020, as compared to the second quarter of 2019.

Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019

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

Six Months Ended June 30,

($ in millions)

Enterprise Solutions

Business Solutions

Public Sector Solutions

Gross Profit:

Enterprise Solutions

Business Solutions

Public Sector Solutions

Net sales decreased for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, as explained below:

● Net sales of $580.2 million for the Enterprise Solutions segment reflect a decrease of $13.5 million, or 2.3%, year-over-year as customers and business partners face the challenges of the decline in macroeconomic conditions resulting from COVID-19.

Net sales of desktop, software, and displays and sound products decreased year-over-year by $14.0 million, $12.5 million, and $11.1 million, respectively.

These decreases were partially offset by increases in net/com and accessory products of $17.0 million and $7.6 million, respectively.

● Net sales of $469.9 million for the Business Solutions segment reflect a decrease of $54.1 million, or 10.3% year-over-year.

The majority of the customers served by our Business Solutions segment are small- to medium-sized business, which have been heavily impacted by the decline in macroeconomic conditions in the quarter resulting from the COVID-19 pandemic.

We experienced declines in net sales across virtually all of our product lines, including decreases in desktop, software, net/com, and other hardware/services of $13.8 million, $13.3 million, $9.8 million, and $8.2 million, respectively.

● Net sales of $211.8 million for the Public Sector Solutions segment decreased by $44.5 million, or 17.4%, compared with the same period a year ago.

We experienced decreases year-over-year in other hardware and services of $14.3 million, primarily as a result of the decline in the current macroeconomic environment, along with some larger projects with the Federal government in the half of 2019 that did not repeat in the current year.

Net sales of software and servers/storage products also decreased by $14.5 million and $12.8 million, respectively, compared with the prior year.

These decreases in net sales were partially offset by an increase in sales of notebooks/mobility products of $17.2 million, primarily driven by orders from educational institutions preparing for and implementing remote learning capabilities.

Gross profit for the six months ended June 30, 2020 decreased year-over-year in dollars, but increased as a percentage of net sales (gross margin), as explained below:

● Gross profit for the Enterprise Solutions segment decreased year-over-year, primarily due to the 2.3% decrease in net sales.

The decrease in gross margin in the quarter of 30 basis points was driven by fluctuations in customer and hardware product mix.

● Gross profit for the Business Solutions segment decreased as a result of an 10.3% decrease in net sales.

However, gross margin increased year-over-year by 40 basis points, resulting from higher invoice selling margins and a greater percentage of our software sales in the current quarter reported on a net basis.

● Gross profit for the Public Sector Solutions segment decreased by $2.4 million year-over-year, primarily as a result of lower net sales in the current period.

Gross margin improved by 140 basis points based on changes in

customer mix, improved hardware margins, and a higher percentage of our software sales in the current period reported on a net basis.

Selling, general and administrative expenses increased in dollars and as a percentage of net sales in the six months ended June 30, 2020 compared to the six months ended June 30, 2019.

SG&A expenses attributable to our three segments and the remaining unallocated Headquarters/Other group expenses are summarized in the table below (dollars in millions):

Six Months Ended June 30,

($ in millions)

Enterprise Solutions

Business Solutions

Public Sector Solutions

Headquarters/Other, unallocated

● SG&A expenses for the Enterprise Solutions segment increased in dollars and as a percentage of net sales.

The year-over-year change in SG&A dollars was primarily attributable to a $1.0 million increase in bad debt expense, resulting from anticipated collection challenges from customers who have been significantly impacted by the COVID-19 pandemic, and a $0.6 million increase in the use of Headquarter services, which included increased contractor and consulting fees associated with the deployment of our new ERP system.

These increases were partially offset by a decrease of $1.3 million in product marketing and advertising expense.

There were no other costs incurred during the quarter that had an individually significant impact on the change period-over-period.

SG&A expenses as a percentage of net sales was 9.1% for the Enterprise Solutions segment in the first half of 2020, which reflects an increase of 30 basis points.

This increase year-over-year is primarily attributable to lower net sales and increased spending compared with the same period a year ago .

● SG&A expenses for the Business Solutions segment increased in both dollars and as a percentage of net sales.

The year-over-year increase in SG&A dollars was primarily driven by a $3.3 million increase in bad debt expense resulting from higher expected credit losses from customers who have been significantly impacted by the COVID-19 pandemic.

Personnel costs, including merit increases and variable compensation associated with higher gross profit, also increased by $1.8 million, while the use of Headquarter services increased by $1.3 million.

SG&A expenses as a percentage of net sales was 14.8% for the Business Solutions segment in the first quarter of 2020 compared to 14.3% in the first quarter of 2019, which reflects an increase of 46 basis points year-over-year, resulting from spending that outpaced net sales growth compared with the same period a year ago.

The use of Headquarter services also increased by $1.9 million year-over-year, driven, in part, by an increase in contractor and consulting fees associated with the deployment of our new ERP system .

These increases were partially offset by a decrease in product marketing and advertising expense of $1.2 million.

SG&A expenses as a percentage of net sales was 16.4% for the Business Solutions segment in the first half of 2020 compared to 13.9% in the first half of 2019, which reflects an increase of 250 basis points year-over-year, resulting from lower net sales and increased spending compared with the same period a year ago.

● SG&A expenses for the Public Sector Solutions segment increased in both dollars and as a percentage of net sales.

Personnel costs, including merit increases and variable compensation associated with higher gross profit, increased by $0.8 million year-over-year, while the use of Headquarter services increased by $0.6 million.

SG&A expenses as a percentage of net sales was 17.8% for the Public Sector Solutions segment in the first quarter of 2020, which reflects an increase of 225 basis points.

This increase year-over-year is primarily attributable to spending that outpaced net sales growth compared with the same period a year ago .

SG&A expenses for the Headquarters/Other group increased primarily due to a $3.4 million increase in personnel-related costs driven primarily by a higher headcount, increased payroll expense, and increased variable compensation associated with higher profits.

These increases were partially offset by a decrease in unallocated executive oversight costs of $2.4 million.

The Headquarters/Other group provides services to the three segments in areas such as finance, human resources, IT, marketing, and product management.

operating costs associated with such corporate Headquarters services are charged to the segments based on their estimated usage of the underlying services.

The amounts shown in the table above represent the remaining unallocated costs.

Income from operations for the first quarter of 2020 increased to $20.7 million, compared to $17.4 million for the first quarter of 2019, primarily due to the increase in net sales and gross profit year-over-year.

Income from operations as a percentage of net sales was 2.9% for the first quarter of 2020, compared to 2.8% of net sales for the prior year quarter, primarily as a result of the growth rate in gross profit slightly exceeding the growth rate in SG&A expenses.

Our effective tax rate was 28.2% for the first quarter of 2020, compared to 27.7% for the first quarter of 2019.

The increase in SG&A dollars year-over-year is almost entirely attributable to an increase in the usage of Headquarter services of $0.9 million, which included an increase in contractor and consulting fees associated with the deployment of our new ERP system .

This increase was partially offset by a decrease in personnel costs, driven by lower variable compensation associated with lower gross profit.

SG&A expenses as a percentage of net sales was 16.0% for the Public Sector Solutions segment in the first half of 2020, which reflects an increase of 290 basis points.

This increase year-over-year is primarily attributable to lower net sales and increased spending compared with the same period a year ago .

● SG&A expenses for the Headquarters/Other group decreased primarily due to a $3.4 million decrease in unallocated executive oversight costs year-over-year.

This increase was partially offset by increases in personnel costs of $1.5 million and professional service fees of $1.3, which were primarily driven by an increase in contractor and consulting fees arising from the deployment of our new ERP system in the second quarter of 2020.

Restructuring and other charges in the current year of $1.0 million were incurred in the second quarter of 2020 and related to an involuntary reduction in workforce across our business segments, and included cash severance payments and other related termination benefits .

Restructuring and other charges were $0.7 million in the six months ended June

30, 2019 and related to a reduction in workforce in our Headquarters/Other group, and included cash severance payments and other related benefits.

Also included were costs incurred related to the closing of one of our office facilities.

Income from operations for the six months ended June 30, 2020 decreased to $31.2 million, compared to $49.7 million for the six months ended June 30, 2019, primarily due to the decreases in net sales and gross profit, along with an increase in SG&A expense year-over-year.

Income from operations as a percentage of net sales decreased to 2.5% for the second quarter of 2020, compared to 3.6% of net sales for the prior year, primarily due to the decrease in net sales and increase in SG&A expenses year-over-year.

Our effective tax rate was 28.1% for the six months ended June 30, 2020, compared to 27.4% for the six months ended June 30, 2019.

We expect our corporate income tax rate for 2020 to range from 26% to 28%.

Net income for the first quarter of 2020 increased to $14.9 million, compared to $12.7 million for the first quarter of 2019, primarily due to higher gross profit and an increase in gross margin which outpaced the growth in operating expenses in the first quarter of 2020, as compared to the first quarter of 2019.

Net income for the six months ended June 30, 2020 decreased to $22.5 million, compared to $36.4 million for the six months ended June 30, 2019, primarily due to lower net sales and gross profit, combined with an increase in operating expenses in the first half of 2020, as compared to the first half of 2019.

Liquidity and Capital Resources

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● Cash on Hand .

At March 31, 2020, we had $111.3 million in cash and cash equivalents.

At June 30, 2020, we had $165.9 million in cash and cash equivalents.

● Cash Generated from Operations .

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● Credit Facilities.

As of March 31, 2020, we had no borrowings under our $50.0 million bank line of credit, which is available until February 10, 2022.

This line of credit can be increased, at our option, to $80.0 million for approved acquisitions or other uses authorized by the bank.

Borrowings are, however, limited by certain minimum collateral and earnings requirements, as described more fully below.

As of June 30, 2020, we had no borrowings under our $50.0 million bank line of credit, which is available until February 10, 2022.

The COVID-19 global pandemic has created some uncertainty in financial liquidity.

A number of customers across affected industries have requested various concessions from us.

We have worked closely with our partners to mitigate the impact these concessions might have on us, but we expect that these situations will continue to arise as we navigate through this crisis.

A number of customers across affected industries have requested various payment term concessions from us.

We have worked closely with our partners to mitigate the impact these concessions might have on us, but we expect that these situations may continue to arise as we navigate through this crisis.

In certain cases, our partners provided us with extended payment terms, which will generally return to their original terms beginning in the third quarter of 2020.

Our ability to continue funding our planned growth, both internally and externally, is dependent upon our ability to generate sufficient cash flow from operations or to obtain additional funds through equity or debt financing, or from other sources of financing, as may be required.

While we do not anticipate needing any additional sources of financing to fund our operations at this time, if demand for IT products declines, or our customers continue to be materially adversely affected by the COVID-19 pandemic, our cash flows from operations may be substantially affected.

See also related risks listed below under “Item 1A.

“Risk Factors.”

See also related risks listed below under “Item 1A.

“Risk Factors.”

Summary of Sources and Uses of Cash

The following table summarizes our sources and uses of cash over the periods indicated:

Three Months Ended

Six Months Ended

($ in millions)

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Net cash used in financing activities

Increase in cash and cash equivalents

Cash provided by operating activities was $44.6 million in the three months ended March 31, 2020.

Cash flow provided by operations in the three months ended March 31, 2020 resulted primarily from net income before depreciation and amortization and a decrease in accounts receivable, which was reduced by $61.5 million year-over-year and was driven by strong collection efforts and the timing of product shipments.

These factors that contributed to the positive inflow of cash from operating activities were partially offset by decreases in accounts payable of $15.5 million, increases in inventory of $12.3 million, and decreases in accrued expenses of $7.2 million compared with the prior year-end balance.

Our days sales outstanding increased to 58 days at March 31, 2020, compared to 55 days at March 31, 2019.

Inventory increased from the prior year-end balance due to higher levels of inventory on-hand related to future backlog and an increase in shipments in transit but not received by our customers as of March 31, 2020 compared to December 31, 2019.

Inventory turns, which measures the number of times inventory was sold and replaced during the period, increased to 21 for the first quarter of 2020 compared to 17 turns for the prior year quarter.

Operating cash flow in the three months ended March 31, 2019 resulted primarily from net income before depreciation and amortization, a decrease in accounts receivable, an increase in accounts payable, and a decrease in prepaid expenses, offset partially by an increase in inventory.

Cash used in investing activities in the three months ended March 31, 2020 represented $4.6 million of purchases of property and equipment.

These expenditures were primarily for computer equipment and capitalized internally-developed software in connection with investments in our IT infrastructure, compared to $6.6 million of purchases of property and equipment in the prior year.

Cash used in financing activities in the three months ended March 31, 2020 consisted primarily of $10.2 million for the repurchase treasury shares and an $8.4 million payment of a special $0.32 per share dividend.

Increase (decrease) in cash and cash equivalents

Cash provided by operating activities was $102.4 million in the six months ended June 30, 2020.

Cash flow provided by operations in the six months ended June 30, 2020 resulted primarily from net income before depreciation and amortization and a decrease in accounts receivable, which was reduced by $99.3 million year-over-year driven primarily by a decrease in net sales and the timing of product shipments.

Accounts payable also increased year-over-year, which led to improved cash flows from operations.

These factors that contributed to the positive inflow of cash from operating activities were partially offset by increases in inventory of $41.0 million.

Our days sales outstanding increased to 68 days at June 30, 2020, compared to 55 days at June 30, 2019.

Inventory increased from the prior year-end balance due to higher levels of inventory on-hand, which resulted primarily from an increase in purchases due to anticipated shortages of certain products and increased prices resulting from the COVID-19 pandemic.

Inventory turns, which measures the number of times inventory was sold and replaced during the period, decreased to 12 for the second quarter of 2020 compared to 17 turns for the prior year quarter.

Operating cash flow in the six months ended June 30, 2019 resulted primarily from net income before depreciation and amortization, an increase in accounts payable, an increase in accrued expenses, and a decrease in prepaid expenses, partially offset by increases in inventory and accounts receivable.

Cash used in investing activities in the six months ended June 30, 2020 represented $8.2 million of purchases of property and equipment.

These expenditures were primarily for computer equipment and capitalized internally-developed software in connection with investments in our IT infrastructure, particularly related to our new ERP system implementation.

In the prior year, we made similar investments with $13.9 million in purchases of property and equipment.

Our new ERP system was deployed in the second quarter of 2020, which resulted in fewer capital expenditures in the current year as the project was winding down.

Cash used in financing activities in the six months ended June 30, 2020 consisted primarily of $10.2 million for the repurchase treasury shares and an $8.4 million payment of a special $0.32 per share dividend.

In the six months ended June 30, 2020, we have purchased 0.2 million shares at an average price of $41.34, and we are authorized to purchase an additional $12.7 million in shares under our Board-approved repurchase program.

In the prior year period, financing activities primarily represented an $8.5 million payment of a special $0.32 per share dividend and $3.5 million for the purchase of treasury shares.

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Below is a summary of certain provisions of our credit facilities and other contractual obligations.

For more information about the restrictive covenants in our debt instruments and inventory financing agreements, see “Factors Affecting Sources of Liquidity”

For more information about the restrictive covenants in our debt instruments and inventory financing agreements, see “Factors Affecting Sources of Liquidity” below.

For more information about our obligations, commitments, and contingencies, see our condensed consolidated financial statements and the accompanying notes included in this Quarterly Report .

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Our borrowing capacity is up to $50.0 million.

Amounts outstanding under the 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 (3.25% at March 31, 2020).

The one-month LIBOR rate at March 31, 2020 was 0.99%.

The one-month LIBOR rate at June 30, 2020 was 0.16%.

In addition, we have the option to increase the facility by an additional $30.0 million to meet additional borrowing requirements.

Our credit facility is subject to certain covenant requirements which are described below under “Factors Affecting Sources of Liquidity.”

At March 31, 2020, $50.0 million was available for borrowing under the facility.

Our credit facility is subject to certain covenant requirements which are described below under “Factors Affecting Sources of Liquidity.” At June 30, 2020, $50.0 million was available for borrowing under the facility.

Off-Balance Sheet Arrangements.

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues and expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors.

Contractual Obligations.

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This credit facility contains two financial covenants:

Our funded debt ratio (defined as the average outstanding advances under the line for the quarter, divided by our consolidated trailing twelve months Adjusted EBITDA—earnings before interest expense, taxes, depreciation, amortization, and special charges—for the trailing four quarters) must not be more than 2.0 to 1.0.

Our outstanding borrowings under the credit facility during the three months ended March 31, 2020 were zero, and accordingly, the funded debt ratio did not limit potential borrowings as of March 31, 2020.

● Our funded debt ratio (defined as the average outstanding advances under the line for the quarter, divided by our consolidated trailing twelve months Adjusted EBITDA—earnings before interest expense, taxes, depreciation, amortization, and special charges—for the trailing four quarters) must not be more than 2.0 to 1.0.

Our outstanding borrowings under the credit facility during the six months ended June 30, 2020 were zero, and accordingly, the funded debt ratio did not limit potential borrowings as of June 30, 2020.

Future decreases in our consolidated trailing twelve months Adjusted EBITDA, could limit our potential borrowings under the credit facility.

● Our minimum consolidated net worth (defined as our consolidated total assets less our consolidated total liabilities) must be at least $346.7 million, plus 50% of consolidated net income for each quarter, beginning with the quarter ended December 31, 2016 (loss quarters not counted).

Such amount was calculated as $468.9 million at March 31, 2020, whereas our consolidated stockholders’

equity at that date was $602.6 million.

Such amount was calculated as $465.2 million at June 30, 2020, whereas our consolidated stockholders’ equity at that date was $611.2 million.

Capital Markets.

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RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS

Recently issued financial accounting standards are detailed in Note 1, “Summary of Significant Accounting Policies,”

in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q.

Recently issued financial accounting standards are detailed in Note 1, “Summary of Significant Accounting Policies,” in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Item 1 of this Quarterly Report on Form 10-Q.

PC CONNECTION, INC.

AND SUBSIDIARIES

PART I―FINANCIAL INFORMATION

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis