Item 2. Management’s Discussion and Analysis
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSI S 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, including the effects of the coronavirus pandemic (“COVID-19”) and successful integration of our new Enterprise Resource Planning (“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” 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. 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: (a) the Business Solutions segment, which serves small- to medium-sized businesses, through our PC Connection Sales subsidiary, (b) the Enterprise Solutions segment, which serves large enterprise customers, through our MoreDirect subsidiary, and (c) the Public Sector segment, which serves federal, state, and local governmental and educational institutions, through our GovConnection subsidiary.
We generate sales through (i) outbound telemarketing and field sales contacts by sales representatives focused on the business, educational, healthcare, and government markets, (ii) our websites, and (iii) direct responses from customers responding to our 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
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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 the formation of our Technical 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 products 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, 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 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 ERP system, which was the result of a multi-year planning and implementation process. The implementation was substantially completed during the second quarter and we continue to work toward complete integration with our business processes and ultimately expect the new ERP system to improve business performance by automating certain manual processes and standardizing business practices.
EFFECTS OF COVID-19
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. On March 11, 2020, the WHO characterized COVID-19 as a global pandemic.
National, state and local governments have responded to the COVID-19 pandemic in a variety of ways, including declaring states of emergency, restricting people from gathering in groups or interacting within a certain physical distance (i.e., social distancing), and in certain cases, ordering businesses to close or limiting operations and instructing people to stay at home. Our company was deemed an essential business by local government authorities as we have worked diligently to supply technology solutions to federal and state government agencies, along with hospitals and other healthcare facilities across the country. 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 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
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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, 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 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 $3.3 million in the nine months ended September 30, 2020.
As the effects of the COVID-19 pandemic continue to evolve, it is difficult to predict and forecast the impact it might have on our business and results of operations in the future. However, we continue to monitor the effects on our customers, suppliers, and the economy as a whole and will adjust our business practices, as necessary, to respond to the changing demand for, and supply of, our products.
See the important information in Item 1A. Risk Factors below, under the caption “The spread of COVID-19 and the imposition of related public health measures and restrictions have, and may in the future, further materially adversely impact our business, financial condition, results of operations and cash flows.”
RESULTS OF OPERATIONS
The following table sets forth information derived from our statements of income expressed as a percentage of net sales for the periods indicated:
Three Months Ended
Nine Months Ended
September 30,
September 30,
($ in millions)
2020
2019
2020
2019
Net sales
$
652.8
$
729.4
$
1,914.6
$
2,103.4
Gross profit
$
107.8
$
118.9
$
309.9
$
335.2
Gross margin
16.5
%
16.3
%
16.2
%
15.9
%
Selling, general and administrative expenses
13.3
%
11.8
%
13.4
%
12.0
%
Income from operations
3.2
%
4.5
%
2.7
%
3.9
%
Net sales of $652.8 million for the third quarter of 2020 reflected a decrease of $76.6 million compared to the third 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 year has been felt by customers across our business and caused a significant reduction in demand for our products. Included in net sales for the three months ended September 30, 2020 was $0.9 million of revenue related to the correction of errors in the second quarter operating results. Gross profit decreased year-over-year by $11.0 million, primarily due to the decline in net sales, partially offset by a $3.2 million reduction to cost of sales related to the correction of errors in the second quarter operating results. SG&A expenses increased by $0.5 million, driven primarily
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by increased professional service fees of $3.2 million resulting from the deployment of our new ERP system and increased depreciation expense of $0.7 million. These increases were partially offset by lower product marketing and advertising expenses of $2.2 million and a decrease in personnel costs of $1.1 million associated with reduced headcount and lower variable compensation. Operating income in the third quarter of 2020 decreased year-over-year both in dollars and as a percentage of net sales by $11.6 million and 125 basis points, respectively, primarily as a result of the decrease in net sales.
Net Sales Distribution
The following table sets forth our percentage of net sales by segment and product mix:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
2020
2019
Sales Segment
Enterprise Solutions
40
%
38
%
43
%
41
%
Business Solutions
35
38
37
38
Public Sector Solutions
25
24
20
21
Total
100
%
100
%
100
%
100
%
Product Mix
Notebooks/Mobility
31
%
30
%
31
%
29
%
Desktops
10
13
10
12
Software
12
11
11
12
Servers/Storage
9
8
9
9
Net/Com Products
10
7
8
7
Displays and Sound
8
10
8
9
Accessories
13
12
14
13
Other Hardware/Services
7
9
9
9
Total
100
%
100
%
100
%
100
%
Gross Profit Margin
The following table summarizes our gross margin, as a percentage of net sales, over the periods indicated:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2020
2019
2020
2019
Sales Segment
Enterprise Solutions
14.8
%
15.1
%
14.5
%
14.8
%
Business Solutions
20.2
19.0
19.4
18.8
Public Sector Solutions
14.1
13.9
13.8
12.9
Total
16.5
%
16.3
%
16.2
%
15.9
%
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Operating Expenses
The following table reflects our SG&A expenses for the periods indicated:
Three Months Ended
Nine Months Ended
September 30,
September 30,
($ in millions)
2020
2019 (1)
2020
2019 (1)
Personnel costs
$
64.8
$
65.9
$
191.2
$
191.4
Advertising
2.4
4.6
9.8
14.2
Facilities operations
2.0
2.1
6.4
6.5
Service contracts/subscriptions
4.0
3.1
10.9
9.2
Professional fees
5.9
2.7
12.5
8.1
Credit card fees
1.7
1.6
4.5
4.7
Depreciation and amortization
3.8
3.1
10.3
10.2
Other
2.2
3.1
11.0
7.8
Total SG&A expense
$
86.8
$
86.2
$
256.6
$
252.1
Percentage of net sales
13.3
%
11.8
%
13.4
%
12.0
%
(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 $1.0 million in the second quarter of 2020, which were related to an involuntary reduction in workforce across our business segments and included cash severance and other related termination benefits. These costs will be paid within a year of termination and any unpaid balances are included in accrued expenses and other liabilities at September 30, 2020. There were no restructuring and other charges recorded in the third quarter of 2020 or 2019.
Year-Over-Year Comparisons
Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019
Changes in net sales and gross profit by segment are shown in the following table:
Three Months Ended September 30,
2020
2019
% of
% of
%
($ in millions)
Amount
Net Sales
Amount
Net Sales
Change
Net Sales:
Enterprise Solutions
$
259.8
39.8
%
$
278.3
38.2
%
(6.6)
%
Business Solutions
231.0
35.4
273.8
37.5
(15.6)
Public Sector Solutions
162.0
24.8
177.3
24.3
(8.6)
Total
$
652.8
100.0
%
$
729.4
100.0
%
(10.5)
%
Gross Profit:
Enterprise Solutions
$
38.4
14.8
%
$
42.1
15.1
%
(8.8)
%
Business Solutions
46.6
20.2
52.1
19.0
(10.6)
Public Sector Solutions
22.8
14.1
24.7
13.9
(7.7)
Total
$
107.8
16.5
%
$
118.9
16.3
%
(9.3)
%
Net sales decreased in the third quarter of 2020 compared to the third quarter of 2019, as explained below:
● Net sales of $259.8 million for the Enterprise Solutions segment reflect a decrease of $18.5 million, or 6.6%, year-over-year. We experienced decreases in net sales across the majority of our product offerings primarily as
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a result of the deterioration in macroeconomic conditions in the third 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. We experienced decreases in net sales of notebooks/mobility products, displays and sound products, accessory products, and desktop products of $14.1 million, $13.1 million, $6.0 million, and $3.4 million, respectively. Net sales of net/com products increased by $16.3 million year-over-year, primarily due to the timing of large project rollouts.
● Net sales of $231.0 million for the Business Solutions segment reflect a decrease of $42.8 million, or 15.6%, 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 $14.7 million, notebooks/mobility products of $6.6 million, server/storage products of $6.1 million, and net/com products of $6.1 million. No other product category decreased by more than $4.9 million. Also included in net sales for the three months ended September 30, 2020 was $2.4 million related to the correction of errors in the second quarter 2020 operating results.
● Net sales of $162.0 million for the Public Sector Solutions segment reflect a decrease of $15.3 million, or 8.6%, compared with the same period a year ago. The decrease in net sales was primarily driven by a deterioration in macroeconomic conditions and strong comparative results in the same quarter a year ago. Though we experienced decreases across the majority of our product lines, including desktop products of $10.6 million, other hardware/services of $8.2 million, and server/storage products of $4.3 million, net sales for software and notebooks/mobility products grew by $4.5 million and $3.6 million, respectively. Also included in net sales for the three months ended September 30, 2020 was a decrease of $1.5 million related to the correction of errors in the second quarter 2020 operating results.
Gross profit for the third 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 6.6% decrease in net sales year-over-year and fluctuations in customer and hardware product mix. Partially offsetting the decrease in gross profit period-over-period was $0.7 million in gross profit recognized in the three months ended September 30, 2020, driven, in part, by a $0.6 million reduction to cost of sales, related to the correction of errors in the second quarter 2020 operating results. The decrease in net sales year-over-year and the change in customer and hardware product mix also explains the decrease in gross margin of 30 basis points in the current quarter.
● Gross profit for the Business Solutions segment decreased year-over-year due primarily to a 15.6% decrease in net sales. Partially offsetting the decrease in gross profit period-over-period was $3.1 million in gross profit recognized in the three months ended September 30, 2020, driven, in part, by a $0.8 million reduction to cost of sales, related to the correction of errors in the second quarter 2020 operating results. Gross margin increased by approximately 120 basis points, driven, in part, by a higher percentage of our software sales in the quarter being reported on a net basis and by the out of period adjustments of $2.4 million in net sales and $0.8 million in cost of sales recorded in the current period.
● Gross profit for the Public Sector Solutions segment decreased as a result of a 8.6% decrease in net sales. Partially offsetting the decrease in gross profit period-over-period was $0.4 million in gross profit recognized in the three months ended September 30, 2020, driven, in part, by a $1.9 million reduction to cost of sales, related to the correction of errors in the second quarter 2020 operating results. Gross margin improved slightly by 20 basis points year-over-year and benefitted from a higher percentage of our software sales in the current period being reported on a net basis, along with the out of period adjustments of $1.5 million in net sales and $1.9 million in cost of sales recorded in the current period.
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Selling, general and administrative expenses increased in dollars and as a percentage of net sales in the third quarter of 2020 compared to the prior year quarter. SG&A expenses attributable to our three segments and the remaining unallocated Headquarters/Other group expenses are summarized in the table below:
Three Months Ended September 30,
2020
2019
% of
% of
Segment Net
Segment Net
%
($ in millions)
Amount
Sales
Amount
Sales
Change
Enterprise Solutions
$
23.6
9.1
%
$
25.8
9.3
%
(8.5)
%
Business Solutions
37.8
16.4
38.6
14.1
(2.1)
Public Sector Solutions
19.6
12.1
17.5
9.9
12.0
Headquarters/Other, unallocated
5.8
4.3
34.9
Total
$
86.8
13.3
%
$
86.2
11.8
%
0.7
%
● SG&A expenses for the Enterprise Solutions segment decreased in dollars and as a percentage of net sales. The year-over-year change in SG&A dollars was attributable to decreased personnel costs of $1.8 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 $0.4 million. SG&A expenses as a percentage of net sales was 9.1% for the Enterprise Solutions segment in the third quarter of 2020, which reflects a decrease of 20 basis points and is a result of cost savings associated with lower net sales that outpaced the decrease in net sales.
● 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 driven primarily by lower product marketing and advertising expenses of $1.5 million . Personnel costs also decreased by $0.5 million period-over-period as a result of 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 credit card fees of $0.2 million. These decreases were partially offset by increases in the use of Headquarter services of $1.7 million, driven, in part, by increased contractor and consulting fees primarily associated with the deployment of our new ERP system. SG&A expenses as a percentage of net sales was 16.4% for the Business Solutions segment in the third quarter of 2020, which reflects an increase of 230 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 increased in dollars and as a percentage of net sales. Personnel costs increased by $1.1 million year-over-year, mainly driven by increases in variable compensation, and an increase in the use of Headquarter services of $0.9 million, which included increased contractor and consulting fees primarily associated with the deployment of our new ERP system . Credit card fees also increased by $0.2 million year-over-year. SG&A expenses as a percentage of net sales was 12.1% for the Public Sector Solutions segment in the third quarter of 2020, which reflects an increase of 220 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 increased primarily as a result of a $3.2 million increase in contractor and consulting fees primarily associated with the deployment of our new ERP system and an increase of $0.8 million in service contracts. Depreciation expense also increased by $0.6 million year-over-year. These increases were partially offset by a reduction in the allocation of Headquarter services of $3.2 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.
Income from operations for the third quarter of 2020 decreased to $21.1 million, compared to $32.7 million for the third quarter of 2019, primarily due to the decreases in net sales and gross profit, along with increased SG&A expenses. Income from operations as a percentage of net sales was 3.2% for the third quarter of 2020, compared to 4.5% of net sales for the prior year quarter, primarily as a result of the decrease in net sales and increase in SG&A expenses.
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Our provision for income taxes in the three months ended September 30, 2020 was $4.1 million, which included $1.7 million of discrete items mainly related to R&D tax credits.
Net income for the third quarter of 2020 decreased to $16.9 million, compared to $23.8 million for the third quarter of 2019, primarily due to lower net sales and gross profit, combined with an increase in operating expenses in the third quarter of 2020, as compared to the third quarter of 2019.
Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019
Changes in net sales and gross profit by segment are shown in the following table (dollars in millions):
Nine Months Ended September 30,
2020
2019
% of
% of
%
($ in millions)
Amount
Net Sales
Amount
Net Sales
Change
Net Sales:
Enterprise Solutions
$
839.9
43.9
%
$
872.0
41.5
%
(3.7)
%
Business Solutions
700.9
36.6
797.7
37.9
(12.1)
Public Sector Solutions
373.8
19.5
433.7
20.6
(13.8)
Total
$
1,914.6
100.0
%
$
2,103.4
100.0
%
(9.0)
%
Gross Profit:
Enterprise Solutions
$
122.0
14.5
%
$
129.1
14.8
%
(5.5)
%
Business Solutions
136.3
19.4
150.1
18.8
(9.2)
Public Sector Solutions
51.6
13.8
56.0
12.9
(7.9)
Total
$
309.9
16.2
%
$
335.2
15.9
%
(7.5)
%
Net sales decreased for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, as explained below:
● Net sales of $839.9 million for the Enterprise Solutions segment reflect a decrease of $32.1 million, or 3.7%, year-over-year as customers and business partners face the challenges of the decline in macroeconomic conditions resulting from COVID-19. Net sales of displays and sound, notebook/mobility, desktop, and software products decreased year-over-year by $24.2 million, $18.5 million, $17.4 million, and $14.6 million, respectively. These decreases were partially offset by increases in net/com and server/storage products of $33.3 million and $14.5 million, respectively, primarily as a result of the timing of large project rollouts.
● Net sales of $700.9 million for the Business Solutions segment reflect a decrease of $96.8 million, or 12.1% 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 2020 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 $28.5 million, $17.1 million, $15.9 million, and $13.2 million, respectively.
● Net sales of $373.8 million for the Public Sector Solutions segment decreased by $59.9 million, or 13.8%, compared with the same period a year ago. We experienced decreases year-over-year in other hardware and services of $22.5 million, primarily as a result of the decline in the current macroeconomic environment, along with some larger projects with the Federal government in the first half of 2019 that did not repeat in the current year. Net sales of desktop, servers/storage, and software products also decreased by $20.6 million, $17.1 million, and $10.0 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 $20.8 million, primarily driven by orders from educational institutions preparing for and implementing remote learning capabilities.
Gross profit for the nine months ended September 30, 2020 decreased year-over-year in dollars, but increased as a percentage of net sales (gross margin), as explained below:
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● Gross profit for the Enterprise Solutions segment decreased year-over-year, primarily due to the 3.7% decrease in net sales. The decrease in gross margin of 30 basis points compared with the prior year was driven by fluctuations in customer and hardware product mix.
● Gross profit for the Business Solutions segment decreased as a result of an 12.1% decrease in net sales. However, gross margin increased year-over-year by 60 basis points, resulting from higher invoice selling margins and a greater percentage of our software sales in the current period reported on a net basis.
● Gross profit for the Public Sector Solutions segment decreased by $4.4 million year-over-year, primarily as a result of lower net sales in the current period. Gross margin improved by 90 basis points based on changes in customer mix, improved hardware margins, and a higher percentage of our software sales in the current period reported on a net basis.
Selling, general and administrative expenses increased in dollars and as a percentage of net sales in the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. SG&A expenses attributable to our three segments and the remaining unallocated Headquarters/Other group expenses are summarized in the table below (dollars in millions):
Nine Months Ended September 30,
2020
2019
% of
% of
Segment Net
Segment Net
%
($ in millions)
Amount
Sales
Amount
Sales
Change
Enterprise Solutions
$
76.6
9.1
%
$
78.2
9.0
%
(2.0)
%
Business Solutions
114.6
16.4
111.6
14.0
2.7
Public Sector Solutions
53.6
14.3
51.3
11.8
4.5
Headquarters/Other, unallocated
11.8
11.0
7.3
Total
$
256.6
13.4
%
$
252.1
12.0
%
1.8
%
● 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 primarily attributable to a $1.8 million decrease in personnel costs, driven mostly by lower variable compensation expense associated with lower gross profit, along with a $1.7 million decrease product marketing and advertising expense. These changes were partially offset by an increase in the use of Headquarter services of $1.2 million, which included increased contractor and consulting fees primarily associated with the deployment of our new ERP system. Bad debt expense also increased period-over-period by $0.5 million due to 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 9.1% for the Enterprise Solutions segment in the nine months ended September 30, 2020, which reflects an increase of 10 basis points. There are no individually significant drivers of this change period-over-period, but is primarily attributable to lower net sales 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 due to a $3.6 million increase in the use of Headquarter services, driven, in part, by an increase in contractor and consulting fees primarily associated with the deployment of our new ERP system . B ad debt expense also increased by $2.8 million year-over-year resulting from higher expected credit losses from customers who have been significantly impacted by the COVID-19 pandemic. These increases were partially offset by decreases in product marketing and advertising expense, credit card fees, and personnel costs of $2.6 million, $0.4 million, and $0.3 million, respectively. SG&A expenses as a percentage of net sales was 16.4% for the Business Solutions segment in the nine months ended September 30, 2020 compared to 14.0% in the prior year, which reflects an increase of 240 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. The increase in SG&A dollars year-over-year was driven by an increase in the usage of Headquarter services of $1.8 million, which included an increase in contractor and consulting fees primarily associated with the deployment of our new ERP system , and an increase in personnel costs of $0.4 million. SG&A expenses as
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a percentage of net sales was 14.3% for the Public Sector Solutions segment in the nine months ended September 30, 2020, which reflects an increase of 250 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 increased primarily as a result of a $4.5 million increase in contractor and consulting fees primarily associated with the deployment of our new ERP system and an increase of $1.6 million in service contracts. Personnel costs also increased by $1.5 million year-over-year. These increases were partially offset by a reduction in the allocation of Headquarter services of $6.6 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.
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 nine months ended September 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 nine months ended September 30, 2020 decreased to $52.3 million, compared to $82.4 million for the nine months ended September 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 2.7% for the nine months ended September 30, 2020, compared to 3.9% of net sales for the same period in the prior year, primarily due to the decrease in net sales and increase in SG&A expenses year-over-year.
Our provision for income taxes in the nine months ended September 30, 2020 was $12.9 million, which included $1.7 million of discrete items mainly related to R&D tax credits recognized in the third quarter.
Net income for the nine months ended September 30, 2020 decreased to $39.5 million, compared to $60.1 million for the nine months ended September 30, 2019, primarily due to lower net sales and gross profit, combined with an increase in operating expenses in the first three quarters of 2020, as compared to the first three quarters of 2019.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been internally generated funds from operations and borrowings under our bank line of credit. We have used those funds to meet our capital requirements, which consist primarily of working capital for operational needs, capital expenditures for computer equipment and software used in our business, special dividend payments, repurchases of common stock for treasury, and as opportunities arise, acquisitions of businesses. Market conditions impact and help determine our strategic use of funds.
We believe that funds generated from operations, together with available credit under our bank line of credit, will be sufficient to finance our working capital, capital expenditures, and other requirements for at least the next twelve calendar months. Our investments in IT systems and infrastructure are designed to enable us to operate more efficiently and to provide our customers enhanced functionality.
We expect to meet our cash requirements for the next twelve months through a combination of cash on hand, cash generated from operations, and borrowings under our bank line of credit, as follows:
● Cash on Hand . At September 30, 2020, we had $108.1 million in cash and cash equivalents.
● Cash Generated from Operations . We expect to generate cash flows from operations in excess of operating cash needs by generating earnings and managing net changes in inventories and receivables with changes in payables to generate a positive cash flow.
● Credit Facilities. As of September 30, 2020, we had no borrowings under our $50.0 million bank line of credit, which is available until February 10, 2022.
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The COVID-19 global pandemic has created some uncertainty in financial liquidity. A number of customers across affected industries have requested various payment term concessions from us. We have worked closely with our partners to mitigate the impact these concessions might have on us, but we expect that these situations may continue to arise as we navigate through this crisis. In certain cases, our partners have previously provided us with extended payment terms, which generally returned to their original terms beginning in the third quarter of 2020.
Our ability to continue funding our planned growth, both internally and externally, is dependent upon our ability to generate sufficient cash flow from operations or to obtain additional funds through equity or debt financing, or from other sources of financing, as may be required. While we do not anticipate needing any additional sources of financing to fund our operations at this time, if demand for IT products declines, or our customers continue to be materially adversely affected by the COVID-19 pandemic, our cash flows from operations may be substantially affected. See also related risks listed below under “Item 1A. “Risk Factors”.
Summary of Sources and Uses of Cash
The following table summarizes our sources and uses of cash over the periods indicated:
Nine Months Ended
($ in millions)
2020
2019
Net cash provided by operating activities
$
46.4
$
40.0
Net cash used in investing activities
(9.6)
(20.6)
Net cash used in financing activities
(18.8)
(12.6)
Increase in cash and cash equivalents
$
18.0
$
6.8
Cash provided by operating activities was $46.4 million in the nine months ended September 30, 2020. Cash flow provided by operations in the nine months ended September 30, 2020 resulted primarily from net income before depreciation and amortization and an increase in accounts payable, which increased by $48.7 million in the current year and was driven primarily by the timing of payments and, to a lesser extent, extended payment terms from certain vendors. These factors that contributed to the positive inflow of cash from operating activities were partially offset by increases in accounts receivable of $42.6 million in the current year, primarily due to the timing of collections and, in some cases, delayed collections from customers who have received extended payment terms. Our days sales outstanding increased to 73 days at September 30, 2020, compared to 52 days at September 30, 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 September 30, 2020. Inventory turns, which measures the number of times inventory was sold and replaced during the period, decreased to 15 for the third quarter of 2020 compared to 16 turns for the prior year quarter. Operating cash flow in the nine months ended September 30, 2019 resulted primarily from net income before depreciation and amortization, an increase in accrued expenses, and a decrease in prepaid expenses, and partially offset by increases in accounts receivable and inventory.
Cash used in investing activities in the nine months ended September 30, 2020 represented $9.6 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, particularly related to our new ERP system implementation. In the prior year, we made similar investments with $20.6 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 nine months ended September 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 nine months ended September 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 $4.4 million for the purchase of treasury shares.
Debt Instruments, Contractual Agreements, and Related Covenants
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
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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 .
Bank Line of Credit . Our bank line of credit extends until February 2022 and is collateralized by our accounts receivable. 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 September 30, 2020). The one-month LIBOR rate at September 30, 2020 was 0.15%. 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 September 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.
Contractual Obligations. The disclosures relating to our contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2019 have not materially changed since the report was filed.
Factors Affecting Sources of Liquidity
Internally Generated Funds. The key factors affecting our internally generated funds are our ability to minimize costs and fully achieve our operating efficiencies, timely collection of our customer receivables, and management of our inventory levels. These factors may also be adversely impacted by the COVID-19 pandemic.
Credit Facility. Our credit facility contains certain financial ratios and operational covenants and other restrictions (including restrictions on additional debt, guarantees, and other distributions, investments, and liens) with which we and all of our subsidiaries must comply. Our credit facility does not include restrictions on future dividend payments. Any failure to comply with the covenants and other restrictions would constitute a default and could prevent us from borrowing funds under this line of credit. 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 nine months ended September 30, 2020 were zero, and accordingly, the funded debt ratio did not limit potential borrowings as of September 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 $473.7 million at September 30, 2020, whereas our consolidated stockholders’ equity at that date was $628.3 million.
Capital Markets. Our ability to raise additional funds in the capital market depends upon, among other things, general economic conditions, the condition of the information technology industry, our financial performance and stock price, and the state of the capital markets.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies have not materially changed from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2019.
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.
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PC CONNECTION, INC. AND SUBSIDIARIES
PART I―FINANCIAL INFORMATION
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.