Item 2. Management’s Discussion and Analysis
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSI S OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS
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 Securities Exchange Act of 1934, as amended, or 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. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be accomplished. The following is a list of some, but not all, of the factors that could cause actual results or events to differ materially from those anticipated:
• we have experienced variability in sales and may not be able to maintain profitable operations;
• substantial competition could reduce our market share and may negatively affect our business;
• we face and will continue to face significant price competition, which could result in a reduction of our profit margins;
• 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;
• instability in economic conditions and government spending may adversely affect our business and reduce our operating results;
• the loss of any of our major vendors could have a material adverse effect on our business;
• virtualization of IT resources and applications, including networks, servers, applications, and data storage may disrupt or alter our traditional distribution models;
• the methods of distributing IT products are changing, and such changes may negatively impact us and our business;
• we depend heavily on third-party shippers to deliver our products to customers and would be adversely affected by a service interruption by these shippers;
• we may experience increases in shipping and postage costs, which may adversely affect our business if we are not able to pass such increases on to our customers;
• we may experience a reduction in the incentive programs offered to us by our vendors;
• should our financial performance not meet expectations, we may be required to record a significant charge to earnings for impairment of goodwill and other intangibles;
• we are exposed to inventory obsolescence due to the rapid technological changes occurring in the IT industry;
• we are exposed to accounts receivable risk and if customers fail to timely pay amounts due to us our business, results of operations and/or cash flows could be adversely affected;
• we are dependent on key personnel and, more generally, skilled personnel in all areas of our business and the loss of key persons or the inability to attract, train and retain qualified personnel could adversely impact our business;
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• cyberattacks or the failure to safeguard personal information and our information technology systems could result in liability and harm our reputation, which could adversely affect our business.
• we are exposed to risks from legal proceedings and audits, which may result in substantial costs and expenses or interruption of our normal business operations.
• the failure to comply with our public sector contracts could result in, among other things, fines or liabilities; and
• we are controlled by one principal stockholder
These risks have the potential to impact the recoverability of the assets recorded on our balance sheets, including goodwill or other intangibles. Additionally, many of these risks are currently amplified by and may, in the future, continue to be amplified by the prolonged impact of the COVID-19 pandemic. 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, 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, 2020. 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 medium-to-large corporations, through our MoreDirect subsidiary, and (c) the Public Sector Solutions 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 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
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gross margins. We expect these service offerings and technical certifications to continue to play a role in sales generation and improve gross margins in this competitive environment.
The primary challenges we continue to face in effectively managing our business are: (1) increasing our revenues while at the same time improving our gross margin in all three segments, (2) recruiting, retaining, and improving the productivity of our sales 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 continue to expand our IT solutions business, which requires 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.
EFFECTS OF COVID-19
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.
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 September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Net sales (in millions)
$
751.4
$
652.8
$
2,092.4
$
1,914.6
Gross margin
16.1
%
16.5
%
16.1
%
16.2
%
Selling, general and administrative expenses
12.4
%
13.3
%
13.0
%
13.4
%
Income from operations
3.6
%
3.2
%
3.1
%
2.7
%
Net sales of $751.4 million for the third quarter of 2021 reflected an increase of $98.6 million compared to the third quarter of 2020, which was driven by higher net sales in both our Enterprise Solutions and Business Solutions segments. The increase in net sales was primarily driven by our ability to meet the continued demand from our customers due to the growing hybrid work environment. In addition, we saw manufacturing revenue growth of $27.0 million or 24.4% and healthcare revenue growth of $14.3 million or 9.8% year-over-year. The increase in net sales was also due to lower sales of the same quarter a year ago primarily due to the impact of the COVID-19 pandemic. Gross profit increased year-over-year by $12.9 million, primarily due to the increase of higher margin sales and the increase in total net sales. SG&A expenses increased year-over-year by $6.6 million, driven primarily by increased personnel cost of $5.7 million associated with higher variable compensation due to the higher gross profit. The higher SG&A expenses were also attributable to an increase in marketing expenses of $1.8 million, an increase in service contracts of $0.2 million, and an increase in credit card fees of $0.6 million. Those increases were partially offset by the lower professional fees of $2.1 million. Operating income in the third quarter of 2021 increased year-over-year both in dollars and as a percentage of net sales by $6.3 million and 40 basis points, respectively, primarily as a result of the increase in net sales.
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Net Sales Distribution
The following table sets forth our percentage of net sales by segment and product mix:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Sales Segment
Enterprise Solutions
41
%
40
%
42
%
43
%
Business Solutions
38
35
38
37
Public Sector Solutions
21
25
20
20
Total
100
%
100
%
100
%
100
%
Product Mix
Notebooks/Mobility
40
%
31
%
38
%
31
%
Desktops
9
10
9
10
Software
8
12
9
11
Servers/Storage
7
9
7
9
Net/Com Product
7
10
7
8
Displays and sound
10
8
10
8
Accessories
12
13
12
14
Other Hardware/Services
7
7
8
9
Total
100
%
100
%
100
%
100
%
Gross Profit Margin
The following table summarizes our gross margin, as a percentage of net sales, over the periods indicated:
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
2021
2020
Sales Segment
Enterprise Solutions
14.7
%
14.8
%
14.8
%
14.5
%
Business Solutions
19.4
20.2
19.3
19.4
Public Sector Solutions
12.7
14.1
13.0
13.8
Total Company
16.1
%
16.5
%
16.1
%
16.2
%
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Operating Expenses
The following table reflects our SG&A expenses for the periods indicated:
Three Months Ended September 30,
Nine Months Ended September 30,
($ in millions)
2021
2020
2021
2020
Personnel costs
$
70.5
$
64.8
$
205.6
$
191.2
Advertising
4.2
2.4
10.7
9.8
Service contracts/subscriptions
4.2
4.0
13.0
10.9
Professional fees
3.8
5.9
13.0
12.5
Depreciation and amortization
2.9
3.8
9.2
10.3
Credit card fees
2.2
1.7
5.3
4.5
Facilities operations
2.1
2.0
6.4
6.4
Other
3.5
2.2
9.1
11.0
Total SG&A expense
$
93.4
$
86.8
$
272.3
$
256.6
As a percentage of net sales
12.4
%
13.3
%
13.0
%
13.4
%
Year-Over-Year Comparisons
In this section and elsewhere in this Quarterly Report on Form 10-Q we refer to changes in year-over-year results. Unless context otherwise requires, such references refer to changes between the three months ended September 30, 2021 and the three months ended September 30, 2020 and changes between the nine months ended September 30, 2021 and the nine months ended September 30, 2020.
Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020
Changes in net sales and gross profit by segment are shown in the following table (dollars in millions):
Three Months Ended September 30,
2021
2020
% of
% of
%
Amount
Net Sales
Amount
Net Sales
Change
Net Sales:
Enterprise Solutions
$
309.7
41.2
%
$
259.8
39.8
%
19.2
%
Business Solutions
281.4
37.5
231.0
35.4
21.8
Public Sector Solutions
160.3
21.3
162.0
24.8
(1.0)
Total
$
751.4
100.0
%
$
652.8
100.0
%
15.1
%
Gross Profit:
Enterprise Solutions
$
45.7
14.8
%
$
38.4
14.8
%
19.0
%
Business Solutions
54.7
19.4
46.6
20.2
17.4
Public Sector Solutions
20.3
12.7
22.8
14.1
(11.0)
Total
$
120.7
16.1
%
$
107.8
16.5
%
12.0
%
Net sales increased in the third quarter of 2021 compared to the third quarter of 2020, as explained below:
● Net sales of $309.7 million for the Enterprise Solutions segment reflect an increase of $49.9 million, or 19.2%, year-over-year. We experienced increases in net sales of notebooks/mobility and displays and sound of $53.9 million and $17.0 million, respectively. Those increases were partially offset by the decreases in net sales of servers/storage, other hardware/services, and net/com products of $11.3 million, $5.8 million and $4.1 million, respectively. We believe these increases were primarily driven by the increased demand from customers in the healthcare and manufacturing industries as organizations continue to invest in technology to implement automation and data security.
● Net sales of $281.4 million for the Business Solutions segment reflect an increase of $50.4 million, or 21.8%, year-over-year. The increase in net sales was also driven by strong growth in cloud-based and security software
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net sales. We experienced increases in net sales of notebooks/mobility products of $37.2 million as a result of shift to work-from-anywhere strategy. The net sales of servers/storage, displays and sound products and desktops also increased by $5.6 million, $5.2 million and $2.2 million, respectively.
● Net sales of $160.3 million for the Public Sector Solutions segment reflect a decrease of $1.7 million, or 1.0%, compared with the same period a year ago. Sales to state and local government and educational institutions increased by 2.5%, compared to the prior year quarter, while sales to the federal government decreased by 15.8% primarily due to the timing of customer rollouts. Net sales of software products and net/com products decreased by $8.0 million and $7.2 million, respectively, compared with the same quarter of the prior year. Those decreases were partially offset by the increases in net sales of notebooks/mobility and other hardware/services of $10.4 million and $2.9 million, respectively.
Gross profit for the third quarter of 2021increased year-over-year in dollars but decreased as a percentage of net sales (gross margin), as explained below:
● Gross profit for the Enterprise Solutions segment increased primarily as a result of the 19.2% increase in net sales year-over-year. The gross margin was flat in comparison to the same period of the prior year.
● Gross profit for the Business Solutions segment increased year-over-year primarily due to a 21.8% increase in net sales. Gross margin percentage decreased by approximately 80 basis points, primarily due to changes in product mix.
● Gross profit for the Public Sector Solutions segment decreased as a result of a 1.0% decrease in net sales. Gross margin percentage decreased by 140 basis points year-over-year due to a shift in product mix and a decrease in software sales recorded on a net basis.
Selling, general and administrative expenses increased in dollars but decreased as a percentage of net sales in the third quarter of 2021 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 (dollars in millions):
Three Months Ended September 30,
2021
2020
% of
% of
Segment Net
Segment Net
%
Amount
Sales
Amount
Sales
Change
Enterprise Solutions
$
26.5
8.6
%
$
23.6
9.1
%
12.3
%
Business Solutions
41.9
14.9
37.8
16.4
10.8
Public Sector Solutions
19.7
12.3
19.6
12.1
0.5
Headquarters/Other, unallocated
5.3
5.8
(8.6)
Total
$
93.4
12.4
%
$
86.8
13.3
%
7.6
%
● 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 $1.9 million, driven primarily by higher variable compensation expense associated with higher gross profit, along with a $0.7 million increase in bad debt expense. SG&A expenses as a percentage of net sales were 8.6% for the Enterprise Solutions segment in the third quarter of 2021, which reflects a decrease of 50 basis points. This decrease is a result of higher sales in the quarter compared with the same period a year ago.
● SG&A expenses for the Business Solutions segment increased in dollars but decreased as a percentage of net sales. The year-over-year change in SG&A dollars was driven primarily by higher advertising costs of $1.5 million compared to the same period last year, primarily due to increased marketing activities. This year-over-year increase in SG&A expenses was also attributable to a $1.2 million increase in the use of Headquarter services as well as a $0.4 million increase in bad debt expense. Additionally, personnel costs increased by $0.8 million compared to the same period last year, primarily due to the higher variable compensation expense associated with higher gross profit. SG&A expenses as a percentage of net sales were 14.9% for the Business Solutions segment in the third quarter of 2021, which reflects a decrease of 150 basis points and is a result of higher sales in the quarter compared with the same period a year ago.
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● SG&A expenses for the Public Sector Solutions segment increased in dollars as well as a percentage of net sales. The increase is primarily driven by an increase in the use of Headquarter services of $0.6 million. The year-over-year increase was partially offset by lower personnel costs. SG&A expenses as a percentage of net sales was 12.3% for the Public Sector Solutions segment in the third quarter of 2021, which reflects an increase of 20 basis points and was due to the higher headquarter costs allocation.
● SG&A expenses for the Headquarters/Other group decreased by $0.5 million. This decrease was primarily due to a decrease in unallocated executive oversight costs year-over-year. 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 2021 increased to $27.3 million, compared to $21.1 million for the third quarter of 2020, primarily due to the increases in net sales and gross profit. Income from operations as a percentage of net sales was 3.6% for the third quarter of 2021, compared to 3.2% for the prior year quarter, primarily driven by higher net sales as well as lower SG&A expenses as a percentage of net sales.
Our provision for income taxes in the three months ended September 30, 2021 was $7.3 million, which included $0.3 million of discrete items mainly related to R&D tax credits. 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 2021 increased to $20.0 million, compared to $16.9 million for the third quarter of 2020, primarily due to higher net sales and gross profit.
Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020
Changes in net sales and gross profit by segment are shown in the following table (dollars in millions):
Nine Months Ended September 30,
2021
2020
% of
% of
%
Amount
Net Sales
Amount
Net Sales
Change
Net Sales:
Enterprise Solutions
$
882.2
42.2
%
$
839.9
43.9
%
5.0
%
Business Solutions
795.0
38.0
700.9
36.6
13.4
Public Sector Solutions
415.2
19.8
373.8
19.5
11.1
Total
$
2,092.4
100.0
%
$
1,914.6
100.0
%
9.3
%
Gross Profit:
Enterprise Solutions
$
130.1
14.7
%
$
122.0
14.5
%
6.6
%
Business Solutions
153.4
19.3
136.3
19.4
12.5
Public Sector Solutions
54.0
13.0
51.6
13.8
4.7
Total
$
337.5
16.1
%
$
309.9
16.2
%
8.9
%
Net sales increased for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020, as explained below:
● Net sales of $882.2 million for the Enterprise Solutions segment reflect an increase of $42.3 million, or 5.0%, year-over-year as a result of the improvement in our ability to navigate the ongoing supply chain constrains on behalf of our customers. Net sales of notebooks/mobility, displays and sound, and desktops increased year-over-year by $71.5 million, $27.6 million, and $9.1 million, respectively. These increases were partially offset by decreases in accessories, other hardware/services, net/com products, servers/storage, and software of $32.8 million, $13.3 million, $7.8 million, $6.2 million, and $5.9 million, respectively.
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● Net sales of $795.0 million for the Business Solutions segment reflect an increase of $94.1 million, or 13.4% year-over-year. The increase in net sales was primarily driven by strong growth in cloud-based and security software net sales. We experienced increases in notebooks/mobility, other hardware/services, displays and sound, net/com products and accessories of $74.5 million, $8.8 million, $7.6 million, $6.9 million and $6.8 million, respectively. Those increases were partially offset by the decrease of net sales of $3.8 million in desktops.
● Net sales of $415.2 million for the Public Sector Solutions segment increased by $41.4 million, or 11.1%, compared with the same period a year ago. The increase was primarily driven by the timing of a large project rollout to the federal government and an increase of sales in state, local government and educational institutions. Net sales of notebooks/mobility products and other hardware/services products increased by $50.6 million and $6.8 million, respectively, compared with the prior year, which was partially offset by the decrease of net sales in net/com products, software and servers/storage of $6.8 million, $4.6 million, and $4.4 million, respectively.
Gross profit for the nine months ended September 30, 2021 increased year-over-year in dollars as well as a percentage of net sales (gross margin), as explained below:
● Gross profit for the Enterprise Solutions segment increased year-over-year, primarily as a result of the 5.0% increase in net sales year-over-year. The increase in gross margin in for the nine months ended September 30, 2021 of 20 basis points, compared to the prior year period, was primarily driven by a change of product mix.
● Gross profit for the Business Solutions segment increased as a result of a 13.4% increase in net sales. Gross margin decreased year-over-year by 10 basis points, resulting from a change of product mix.
● Gross profit for the Public Sector Solutions segment increased by $2.4 million year-over-year, primarily as a result of increased net sales. Gross margin decreased by 80 basis points based on changes in product mix, which included decreased sales of higher-margin products.
Selling, general and administrative expenses increased in dollars but decreased as a percentage of net sales in the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. 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,
2021
2020
% of
% of
Segment Net
Segment Net
%
Amount
Sales
Amount
Sales
Change
Enterprise Solutions
$
78.0
8.8
%
$
76.6
9.1
%
1.8
%
Business Solutions
123.8
15.6
114.6
16.4
8.0
Public Sector Solutions
58.2
14.0
53.6
14.3
8.6
Headquarters/Other, unallocated
12.3
11.8
4.2
Total
$
272.3
13.0
%
$
256.6
13.4
%
6.1
%
● 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 primarily attributable to a $2.1 million increase in the use of Headquarter services, primarily due to the higher variable compensation resulting from the higher gross profit of the nine months ended September 30, 2021. These increases were partially offset by a decrease of $0.3 million in bad debt expenses as well as a decrease of $0.2 million in depreciation and amortization expenses. SG&A expenses as a percentage of net sales were 8.8% for the Enterprise Solutions segment for the nine months ended September 30, 2021, which reflects a decrease of 30 basis points. This decrease year-over-year was due to the higher net sales for the nine months ended September 30, 2021.
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● SG&A expenses for the Business Solutions segment increased in dollars but decreased as a percentage of net sales. The year-over-year increase in SG&A dollars was primarily driven by the increased Headquarter services of $6.3 million, including the higher variable compensation expenses resulting from the higher gross profit of for the nine months ended September 30, 2021. The year-over-year increase in SG&A was also attributable to the increased personnel costs and advertising costs in the amount of $3.1 million and $1.3 million respectively. Those increases were partially offset by lower bad debt expense of $2.0 million. Higher bad debt expense in the prior year was primarily due to the higher expected credit losses from customers who had been significantly impacted by the COVID-19 pandemic. SG&A expenses as a percentage of net sales were 15.6% for the Business Solutions segment for the nine months ended September 30, 2021 compared to 16.4% for the same period in 2020, which reflects a decrease of 80 basis points year-over-year, resulting from higher net sales compared with the same period a year ago.
● SG&A expenses for the Public Sector Solutions segment increased in dollars but decreased as a percentage of net sales. The increase in SG&A dollars year-over-year is attributable to an increase in the usage of Headquarter services of $3.1 million, which included an increase in variable compensation expenses associated with the higher gross profit for the nine months ended September 30, 2021 . Increased personnel costs of $0.7 million as well as the increased bad debt expense of $0.2 million also contributed to the year-over-year SG&A increase. SG&A expenses as a percentage of net sales were 14.0 % for the Public Sector Solutions segment for the nine months ended September 30, 2021, which reflects a decrease of 30 basis points. This decrease year-over-year is primarily attributable to higher net sales compared with the same period a year ago .
● SG&A expenses for the Headquarters/Other group increased by $0.5 million primarily due to an increase in unallocated executive oversight costs year-over-year. This increase was primarily driven by the increased variable compensation costs resulting from the higher gross profit during the current year.
Income from operations for the nine months ended September 30, 2021 increased to $65.2 million, compared to $52.3 million for the nine months ended September 30, 2020 primarily due to the increases in net sales and gross profit. Income from operations as a percentage of net sales increased to 3.1% for the nine month ended September 30, 2021, compared to 2.7% of net sales for the prior year, primarily due to the increase in net sales and the decrease in SG&A expenses as a percentage of net sales year-over-year.
Our provision for income taxes in the nine months ended September 30, 2021 was $17.7 million, which included $0.3 million of discrete items mainly related to R&D tax credits recognized in the third quarter. 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 of 2020.
Net income for the nine months ended September 30, 2021 increased to $47.5 million, compared to $39.5 million for the nine months ended September 30, 2020, primarily due to higher net sales and gross profit, combined with a lower operating expenses as a percentage of net sales in 2021, as compared to the same period of 2020.
Liquidity and Capital Resources
Our primary sources of liquidity have historically been internally generated funds from operations and borrowings under our credit facility. 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 credit facility, 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 credit facility, as follows:
● Cash on Hand . At September 30, 2021, we had $89.7 million in cash and cash equivalents.
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● 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 payables to generate a positive cash flow.
● Credit Facility. As of September 30, 2021, we had no borrowings under our $50.0 million credit facility, which is available until February 10, 2022.
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.
Summary of Sources and Uses of Cash
The following table summarizes our sources and uses of cash over the periods indicated:
Nine Months Ended September 30,
2021
2020
Net cash provided by operating activities
$
8.8
$
46.4
Net cash used in investing activities
(5.5)
(9.6)
Net cash used in financing activities
(9.2)
(18.8)
(Decrease) increase in cash and cash equivalents
$
(5.9)
$
18.0
Cash provided by operating activities was $8.8 million in the nine months ended September 30, 2021. Cash flow provided by operations during the nine months ended September 30, 2021, resulted primarily from net income, other non-cash charges adding back and a decrease in accounts receivable, which decreased by $22.4 million for the nine months ended September 30, 2021, and was driven primarily by the timing of collections. These factors that contributed to the positive inflow of cash from operating activities were partially offset by increases in inventory of $34.5 million for the nine months ended September 30, 2021, primarily driven by the increase of inventory purchases for customer requested future rollouts. Accounts payable also decreased by $50.0 million from prior year period which led to offset the positive cash flow from operations. Operating cash flow in the nine months ended September 30, 2020 resulted primarily from net income before depreciation and amortization, a decrease in accounts receivable, an increase in accounts payable, and partially offset by increases in inventory.
In order to manage our working capital and operating cash needs, we monitor our cash conversion cycle, defined as days of sales outstanding in accounts receivable plus days of supply in inventory minus days of purchases outstanding in accounts payable, based on a rolling three-month average. Components of our cash conversion cycle are as follows:
(in days)
September 30,
2021
2020
Days of sales outstanding (DSO) (1)
66
73
Days of supply in inventory (DIO) (2)
25
22
Days of purchases outstanding (DPO) (3)
(31)
(47)
Cash conversion cycle
60
48
(1) Represents the rolling three-month average of the balance of accounts receivable, net at the end of the period, divided by average daily net sales for the same three-month period. Also incorporates components of other miscellaneous receivables.
(2) Represents the rolling three-month average of the balance of merchandise inventory at the end of the period divided by average daily cost of sales for the same three-month period.
(3) Represents the rolling three-month average of the combined balance of accounts payable-trade, excluding cash overdrafts, and accounts payable-inventory financing at the end of the period divided by average daily cost of sales for the same three-month period.
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The cash conversion cycle increased to 60 days at September 30, 2021, compared to 48 days at September 30, 2020. The increase is primarily due to the 16-day decrease of DPO and the 3-day increase of DIO, and partially offset by the 7 day decrease of DSO. The lower DPO was driven by mixing vendors with shorter payment terms in comparison to the prior year. The decrease of DSO was primarily due to lower accounts receivable balance for the quarter ended September 30, 2021 compared to the same period of prior year.
Cash used in investing activities in the nine months ended September 30, 2021 represented $7.1 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. In the prior year, we made similar investments of $9.6 million in purchases of property and equipment. Cash used for capital expenditures for the nine months ended September 30, 2021 was partially offset by $1.5 million of cash proceeds from life insurance.
Cash used in financing activities in the nine months ended September 30, 2021 consisted primarily of an $8.4 million payment of a special $0.32 per share dividend. In the prior year period, financing activities primarily represented an $8.4 million payment of a special $0.32 per share dividend and $10.2 million for the purchase of treasury shares.
Debt Instruments, Contractual Agreements, and Related Covenants
Below is a summary of certain provisions of our credit facility 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” 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 on Form 10-Q .
Credit facility . Our credit facility 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, 2021). The one-month LIBOR rate at September 30, 2021 was 0.08%. 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, 2021, $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.
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.
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 credit facility. This credit facility contains two financial covenants:
● Our funded debt ratio (defined as the average outstanding advances under the credit facility 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 September 30, 2021 were zero, and accordingly, the funded debt ratio did not limit potential borrowings as of September 30, 2021. Future decreases in our consolidated trailing twelve months Adjusted EBITDA, could limit our potential borrowings under the credit facility.
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● 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 $505.6 million at September 30 , 2021, whereas our consolidated stockholders’ equity at that date was $686.2 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, 2020.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
Recently issued financial accounting standards are detailed in Note 1, “Basis of Presentation,” in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, 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.