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Item 7. Management’s Discussion and Analysis

2024-03-07 compared with 2023-03-06 · 137 added, 135 removed, 234 unchanged (54% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to promote understanding of the results of operations and financial conditions.

MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, is intended to promote an understanding of our results of operations and financial condition.

MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K.

This section discusses the results of operations for the year ended December 31, 2023 and year-to-year comparison between the year ended December 31, 2023 and the year ended December 31, 2022.

Discussion of the year ended December 31, 2022 and the year-to-year comparison between the year ended December 31, 2022 and the year ended December 31, 2021 can be found in Part II, Item 7 “Management’s Discussions and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2022.

Our MD&A also includes the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated.

Our MD&A also includes discussion of certain forward-looking trends and other statements that predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated.

See “Cautionary Note Concerning Forward-Looking Statements” and “Item 1A.

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We provide a wide range of IT solutions, from the desktop to the cloud—including computer systems, data center solutions, software and peripheral equipment, networking communications, and other products and accessories that we purchase from manufacturers, distributors, and other suppliers.

Our TSG and state-of-the-art TIDC, with ISO 9001:2015 certified technical configuration lab offer end-to-end services related to the design, configuration, and implementation of IT solutions.

In 2023, we restructured and combined our Technology Solutions Group and Technical Sales Organization into one organization to be referred to as our TSO.

Our TSO and state-of-the-art TIDC, with ISO 9001:2015 certified technical configuration lab offer end-to-end services related to the design, configuration, and implementation of IT solutions.

Our team also provides a comprehensive portfolio of managed services and professional services.

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Our GlobalServe offering ensures worldwide coverage for our multinational customers, delivering global procurement solutions through our network of in-country suppliers in over 150 countries.

The “Connection®” brand includes Connection Business Solutions, Connection Enterprise Solutions, and Connection Public Sector Solutions, which provide IT solutions and services to SMBs, enterprise, and public sector markets.

The “Connection®” brand includes Connection Enterprise Solutions, Connection Business Solutions, and Connection Public Sector Solutions, which provide IT solutions and services to enterprise, SMBs, and public sector markets.

Financial results for each of our segments are included in the financial statements attached hereto.

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 offer a broad selection of over 460,000 products at competitive prices, including products from vendors like Apple, Cisco Systems, Dell, Dell-EMC, Hewlett-Packard Inc., Hewlett-Packard Enterprise, Lenovo, Microsoft, and VMware, and we partner with more than 2,500 suppliers.

We are able to leverage our state-of-the art logistic capabilities to rapidly ship product to customers, typically the same day the order is received.

We generate sales through (i) outbound inside sales and field sales contacts by sales representatives focused on the business, educational, healthcare, retail, manufacturing, and government markets, (ii) our websites, and (iii) direct responses from customers responding to our advertising media.

We offer a broad selection of over 460,000 products at competitive prices, including products from vendors like Apple, Cisco, Dell Inc., Hewlett-Packard Inc., Hewlett-Packard Enterprise, Intel, Lenovo, Microsoft Corporation, and VMware, and we partner with more than 2,500 suppliers.

We are able to leverage our state-of-the art logistic capabilities to rapidly ship product to customers.

As a value-added reseller in the IT supply chain, we do not manufacture IT hardware or software products.

We are dependent on our suppliers—manufacturers and distributors that historically have only sold to resellers rather than directly to end users.

However, manufacturers have, on multiple occasions, sold or 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.

However, certain manufacturers have, on multiple occasions, sold or 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 and, in some cases successfully, eliminate our role.

We believe that the success of these direct sales efforts by manufacturers will depend on their ability to meet our customers’ ongoing demands and provide solutions to meet their needs.

We believe many of our customers seek out comprehensive and integrated IT solutions, rather than the ability to acquire specific IT products on a one-off basis.

Our advantage is our ability to be product-neutral and to provide a broader combination of products, services, and advice tailored to our customers’ needs.

We believe more of our customers are seeking out comprehensive and integrated IT solutions, rather than the ability to acquire specific IT products on a one-off basis.

Our advantage is our ability to be product-neutral and provide a broader combination of products, services, and advice tailored to our customers’ individual 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 TSG, 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.

Through the formation of our TSO, 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.

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 gross margin improvements in this competitive environment.

The primary challenges we continue to face in effectively managing our business are (1) increasing our product and service 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 SG&A expenses while making major investments in our IT systems and solution selling personnel, especially in relation to changing revenue levels.

To support future growth, we are investing in our IT solutions business, which requires the addition of highly skilled service engineers.

To support future growth, we have invested and expect to continue to invest in 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 additional service engineers.

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

Virtual delivery of software products and advanced Internet technology providing customers enhanced functionality have substantially increased customer expectations, requiring us to invest 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.

Trends and Key Factors Affecting our Financial Performance

● As the effects of COVID-19 and its variants 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.

The COVID-19 pandemic has, and may continue to cause supply chain disruptions.

Although we saw some improvement in the supply chain during the second half of 2022, we continue to have some supply chain challenges that may continue in the foreseeable future.

● Inflation due to, among other things, the continuing impacts of the COVID-19 pandemic and uncertain economic environment impacts product costs and wages.

● As the AI market continues to evolve, it is difficult to predict and forecast its potential impact on our business and results of operations in the future.

We may be required to make significant investments to keep up with increasing competition surrounding AI.

Additionally, potential issues with the AI products we sell could have an adverse effect on our business and results of operations in the future.

● Inflation due to, among other things, higher interest rates and the uncertain economic environment, impacts product costs and wages.

The increased product costs and wages due to inflation may adversely affect our business, financial condition and results of operations.

If inflation on products and wages increases beyond our ability to control, we may not be able to adjust prices to sufficiently offset the effect of the various cost increases without negatively impacting customer demand.

● The Federal Reserve recently increased interest rates, and it is anticipated that interest rates will continue to rise.

If product costs and wages increase significantly or for an extended period of time, we may not be able to adjust prices to sufficiently offset the effect of the various cost increases without negatively impacting customer demand.

● The Federal Reserve increased interest rates in 2023, but it is anticipated that interest rates will remain steady and potentially decrease in 2024.

Although we don’t have any borrowing under our credit facility, should we need to borrow in the future, we may be exposed to high interest rates.

Additionally, if interest rates were to decrease, our interest income on our cash equivalents and short-term investments would also decrease.

RESULTS OF OPERATIONS

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Income from operations

Net sales of $3,125.0 million in 2022 reflected an increase of $232.4 million compared to 2021, which was driven by higher net sales across all of our operating segments as shown in the table on page 32 of this Form 10-K.

The increase in net sales was primarily driven by the growing hybrid work trend resulting in higher demand for notebooks/mobility, desktops, and accessories products.

Sales of all of our other product categories also increased year-over-year, as shown in Note 2 of the Consolidated Financial Statements.

The increase in software sales was primarily due to higher volume of security software and software as a service, which are recognized on a net basis.

The continued trend toward higher sales of security software and software as a service has put downward pressure on net sales, while improving gross margins.

This trend is expected to continue in 2023.

Gross profit increased year-over-year by $61.6 million as shown in the table on page 32 of this Form 10-K, primarily due to the increase of net sales.

Gross margin increased year-over-year by 70 basis points as shown in the above table primarily due to an increase in sales of data center products including networking and servers during 2022, as well as an increase in the amount of software sold recognized on a net basis.

SG&A expenses increased year-over-year by $37.5 million, driven primarily by increased personnel cost of $30.6 million and increased advertising costs of $4.4 million.

The majority of the personnel cost increase is due to the increased cost of labor, higher variable compensation due to the higher levels of gross profit, and increased employee benefit costs.

Operating income increased year-over-year both in dollars and as a percentage of net sales by $24.0 million and 60 basis points, respectively, primarily as a result of the increase in net sales.

Net sales of $2,850.6 million in 2023 reflected a decrease of $274.4 million compared to 2022, which was driven by lower net sales for our Enterprise Solutions and Business Solutions segments as shown in the table on page 34 of this Annual Report on Form 10-K.

The decrease in net sales was primarily driven by a decrease in demand for end-point devices resulting in a decrease in net sales of notebooks/mobility of $205.2 million.

Net sales of accessories, displays and sound, and desktops also decreased year-over-year, as shown in Note 2 of the Consolidated Financial Statements.

Gross profit decreased year-over-year by $14.5 million as shown in the table on page 34 of this Annual Report on Form 10-K, primarily due to the decrease in net sales.

Gross margin increased year-over-year by 120 basis points as shown in the above table primarily due to an increase in net sales of higher margin products, such as software and services, which are recognized on a net basis, and net/com products, relative to lower margin products, such as notebooks/mobility and desktops, as evidenced in the below product mix table.

SG&A expenses remained consistent year-over-year in dollars but increased as a percentage of net sales primarily due to the decrease in net sales.

Operating income decreased year-over-year both in dollars and as a percentage of net sales by $17.4 million and 60 basis points, respectively, primarily as a result of the decrease in net sales.

Sales Distribution

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Servers/Storage

Net/Com Product

Net/Com Products

Displays and Sound

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Operating Expenses

The following table reflects our most significant operating expenses for the last three years (in millions of dollars):

The following table reflects our most significant operating expenses for the last three years (dollars in millions):

Years Ended December 31,

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Restructuring and other charges

During the year ended December 31, 2023, we undertook actions to lower our cost structure.

In connection with these initiatives, we incurred restructuring and other charges of $2.7 million for the year ended December 31, 2023.

These restructuring charges were primarily related to an involuntary reduction in our headquarter workforce 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 on the consolidated balance sheets as of December 31, 2023.

The Company is currently evaluating additional restructuring activities for 2024 and beyond.

There were no restructuring related costs incurred for the years ended December 31, 2022 and 2021.

In the year ended December 31, 2020, we undertook actions across the 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 related costs of $1.0 million for the year ended December 31, 2020.

YEAR-OVER-YEAR COMPARISONS

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Public Sector Solutions

Net sales increased by 8.0% to $3,125.0 million in 2022 from $2,892.6 million in 2021, as explained below:

● Net sales of $1,324.4 million for the Enterprise Solutions segment reflect an increase of $74.9 million, or 6.0%, year-over-year as a result of our customers’ needs for notebooks/mobility products to support their work-from-anywhere initiatives.

Net sales of notebooks/mobility, desktops, accessories, and displays and sound increased year-over-year by $33.3 million, $25.0 million, $23.2 million, and $6.7 million, respectively.

These increases were partially offset by decreases in software and servers/storage of $11.2 million and $1.4 million, respectively.

The decrease in software sales was primarily due to an increase in the amount of software sold recognized on a net basis.

● Net sales of $1,245.3 million for the Business Solutions segment reflect an increase of $146.8 million, or 13.4% year-over-year.

The increase in net sales was primarily driven by strong growth in our customers’ needs for notebooks/mobility products to support their work-from-anywhere initiatives.

We experienced increases across all products, most notably in notebooks/mobility, software, displays and sound, accessories, and net/com products of $47.4 million, $27.7 million, $19.3 million, $18.0 million, and $17.0 million, respectively.

● Net sales of $555.3 million for the Public Sector Solutions segment increased by $10.7 million, or 2.0%, compared with the same period a year ago.

The increase was primarily driven by an increase of sales to state and local government and educational institutions, partially offset by the decrease of sales to federal governments.

Net sales of accessories, desktops, displays and sound, and servers/storage increased by $14.3 million, $10.8 million, $8.7 million, and $7.5 million, respectively, compared with the prior year.

Those increases were partially offset by decreases in notebooks/mobility, other hardware/services, software, and net/com products of $19.8 million, $5.5 million, $3.5 million, and $1.8 million, respectively.

Gross profit increased by 13.3% to $526.2 million in 2022 and gross margin increased by 70 basis points to 16.8% in 2022, as explained below:

● Gross profit for the Enterprise Solutions segment increased $14.5 million, or 8.0% year-over-year as referenced in the above table.

This increase is primarily due to the 6.0% increase in net sales.

Gross margin increased 20 basis points compared to the prior year primarily due to an increase in the amount of software sales recognized on a net basis.

● Gross profit for the Business Solutions segment increased $39.5 million, or 18.7% year-over-year as referenced in the above table.

This increase is primarily a result of a 13.4% increase in net sales.

Gross margin increased year-

over-year by 90 basis points, primarily due to an increase in sales of higher-margin networking and servers/storage products, along with an increase in sales of cloud and security software, which are recognized as revenue on a net basis.

● Gross profit for the Public Sector Solutions segment increased by $7.6 million, or 10.5% year-over-year as referenced in the above table, primarily as a result of higher net sales in the current period.

Gross margin increased by 110 basis points primarily due to an increase in higher-margin servers/storage sales, along with an increase in sales of cloud and security software, which are recognized as revenue on a net basis.

SG&A expense in 2022 increased in dollars and as a percentage of net sales compared to the prior year.

Net sales decreased by 8.8% to $2,850.6 million in 2023 from $3,125.0 million in 2022, as explained below:

● Net sales of $1,201.1 million for the Enterprise Solutions segment reflect a decrease of $123.3 million, or 9.3%, year-over-year, primarily due to a decrease in demand of end-point devices.

Net sales of notebooks/mobility, accessories, desktops, and displays and sound decreased year-over-year by $70.5 million, $47.0 million, $27.8 million, and $25.9 million, respectively.

These decreases were partially offset by increases in net sales of net/com products, software, and other hardware/services of $26.5 million, $16.2 million, and $4.8 million, respectively.

● Net sales of $1,075.6 million for the Business Solutions segment reflect a decrease of $169.7 million, or 13.6% year-over-year, primarily due to a decrease in demand of end-point devices.

Net sales of notebooks/mobility, displays and sound, accessories, desktops, servers/storage, and other hardware/services decreased year-over-year by $121.3 million, $26.5 million, $21.5 million, $14.8 million, $13.0 million, and $5.6 million, respectively.

These decreases were partially offset by increases in net sales of net/com products and software of $23.0 million and $9.9 million, respectively.

● Net sales of $573.9 million for the Public Sector Solutions segment reflect an increase of $18.6 million, or 3.3%, year-over-year.

The increase was primarily driven by an increase in sales to federal governments, partially offset by a decrease of sales to state and local government and educational institutions.

Net sales of net/com products, software, and other hardware/services increased year-over-year by $29.9 million, $11.3 million, and $6.8 million, respectively.

These increases were partially offset by decreases in net sales of notebooks/mobility, accessories, and displays and sound of $13.5 million, $8.4 million, and $7.6 million, respectively.

Gross profit decreased by 2.7% to $511.7 million in 2023, while gross margin increased by 120 basis points to 18.0% in 2023, as explained below:

● Gross profit for the Enterprise Solutions segment decreased $16.2 million, or 8.3% year-over-year as referenced in the above table.

This decrease was primarily due to the 9.3% decrease in net sales.

Gross margin increased 20 basis points compared to the prior year primarily due to an increase in net sales of higher margin products, such as net/com products and software, which is recognized on a net basis, relative to lower margin products, such as notebooks/mobility and accessories.

● Gross profit for the Business Solutions segment decreased $3.8 million, or 1.5% year-over-year as referenced in the above table.

This decrease was primarily a result of a 13.6% decrease in net sales.

Gross margin increased 290 basis

points compared to the prior year primarily due to an increase in net sales of higher margin products, such as software, which is recognized on a net basis, and net/com products, relative to lower margin products, such as notebooks/mobility and displays and sound.

● Gross profit for the Public Sector Solutions segment increased by $5.5 million, or 7.0% year-over-year as referenced in the table on the previous page, primarily as a result of higher net sales in the current period.

Gross margin increased 50 basis points compared to the prior year primarily due to an increase in net sales of higher margin products, such as net/com products and software, which is recognized on a net basis, relative to lower margin products, such as notebooks/mobility, accessories, and displays and sound.

SG&A expense in 2023 remained consistent year-over-year in dollars but increased as a percentage of net sales.

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

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Headquarters/Other, unallocated

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

The year-over-year change in SG&A dollars was primarily attributable to a $33.5 million increase in the use of Headquarter services, which include finance, distribution center, human resources, IT, marketing, and product management.

This year-over-year increase was also driven by a $2.3 million increase in personnel costs.

SG&A expenses as a percentage of net sales were 10.7% for the Enterprise Solutions segment for the year ended December 31, 2022, which reflects an increase of 220 basis points.

This increase year-over-year was largely due to the increase in Headquarter services in 2022.

● 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 increases in personnel costs and advertising costs of $6.5 million and $3.0 million, respectively.

This increase was partially offset by a decrease in the use of Headquarter services of $6.3 million, primarily due to an increase in services utilized by the Enterprise Solutions segment.

SG&A expenses as a percentage of net sales were 13.8% for the Business Solutions segment for the year ended December 31, 2022 compared to 15.3% for 2021, which reflects a decrease of 150 basis points year-over-year, primarily due to higher net sales in the current year.

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

The increase in SG&A dollars year-over-year is primarily attributable to increases in personnel costs and advertising costs of $3.6 million and $1.1 million, respectively.

This increase was partially offset by a decrease in the use of Headquarter services of $2.4 million, primarily due to an increase in services utilized by the Enterprise Solutions segment.

SG&A expenses as a percentage of net sales were 14.2% for the Public Sector Solutions segment for the year ended December 31, 2022, which is consistent with the prior year.

● SG&A expenses for the Headquarters/Other group decreased by $3.5 million primarily due to an increase in Headquarter services utilized by the Enterprise Solutions segment, as discussed above.

Income from operations for the year ended December 31, 2022 increased to $120.6 million, compared to $96.5 million for the same period in the prior year, primarily due to the increases in net sales and gross profit explained above.

These increases were partially offset by an increase in SG&A expense year-over-year as explained above.

Income from operations as a percentage of net sales increased to 3.9% for the year ended December 31, 2022, compared to 3.3% of

net sales for the same period in the prior year, primarily due to the increases in net sales and gross profit, partially offset by an increase in SG&A expenses as a percentage of net sales year-over-year.

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

The year-over-year decrease in SG&A dollars was primarily attributable to decreases in the use of Headquarter services, personnel costs, and other expenses of $1.8 million, $1.8 million, and $1.1 million, respectively.

The Headquarter services include services related to finance, distribution center, human resources, IT, marketing, and product management.

These decreases were partially offset by an increase in advertising costs of $2.4 million.

SG&A expenses as a percentage of net sales were 11.5% for the Enterprise Solutions segment for the year ended December 31, 2023, which reflects an increase of 80 basis points and is primarily due to the decrease in net sales.

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

The year-over-year increase in personnel costs of $3.8 million related to investments in resources to strengthen our sales organization was offset by decreases in the use of Headquarter services, other expenses, and advertising costs of $2.4 million, $0.7 million, and $0.6 million, respectively.

SG&A expenses as a percentage of net sales were 15.9% for the Business Solutions segment for the year ended December 31, 2023, which reflects an increase of 210 basis points and is primarily due to the decrease in net sales.

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

The increase in SG&A dollars year-over-year is primarily attributable to an increase in personnel costs of $5.0 million related to investments in resources to strengthen our sales organization.

This increase was partially offset by a decrease in the use of Headquarter services of $1.2 million.

SG&A expenses as a percentage of net sales were 14.6% for the Public Sector Solutions segment for the year ended December 31, 2023, which reflects an increase of 40 basis points and is consistent with the 5.7% increase in SG&A expenses compared to just a 3.3% increase in net sales.

● SG&A expenses for the Headquarters/Other group decreased by $0.6 million primarily due to decreases in personnel costs and professional fees of $3.9 million and $2.5 million, respectively.

These decreases were partially offset by an increase in unallocated Headquarter services of $5.4 million.

Income from operations for the year ended December 31, 2023 decreased to $103.2 million, compared to $120.6 million for the same period in the prior year, primarily due to the decreases in net sales and gross profit explained above.

Income from operations as a percentage of net sales decreased to 3.6% for the year ended December 31, 2023, compared to 3.9% of net sales for the same period in the prior year, primarily due to the decreases in net sales and gross profit.

Other income, net for the year ended December 31, 2023 increased to $10.0 million, compared to $1.1 million for the same period in the prior year, primarily due to an increase in interest income of $8.9 million as a result of higher cash equivalent balances and interest rates on short-term investments.

Income taxes.

Our provision for income taxes for the year ended December 31, 2023 was $29.8 million, compared to $32.4 million for the same period in the prior year.

The decrease in our provision for income taxes was primarily due to the decrease in income from operations, partially offset by the increase in other income, net.

Our effective tax rate was 26.4% for the year-ended December 31, 2023, compared to 26.7% for the year ended December 31, 2022.

The decrease year over year is primarily due to a reduction in state income tax expense resulting from changes in state apportionment factors.

Our provision for income taxes for the year ended December 31, 2022 was $32.4 million.

Our provision for income taxes for the year ended December 31, 2021 was $26.6 million, which included $0.3 million of discrete items mainly related to research and development tax credits recognized in the year ended December 31, 2021.

Net income increased by $19.3 million to $89.2 million for the year ended December 31, 2022, from $69.9 million in the prior year, primarily due to the increase in net sales and gross profit, partially offset by an increase in SG&A expenses in the current year, as explained above.

Net income decreased by $5.9 million to $83.3 million for the year ended December 31, 2023, from $89.2 million in the prior year, primarily due to the decreases in net sales and gross profit, partially offset by an increase in other income, net in the current year, as explained above.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity Overview

Our primary sources of liquidity have historically been internally generated funds from operations and borrowings under our bank line of credit.

Our primary sources of liquidity are internally generated funds from operations, short-term investments, and borrowings under our credit facility.

We have historically used and expect to use in the future 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, repurchases of common stock for treasury, dividend payments, and as opportunities arise, possible acquisitions of new businesses.

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 and beyond such twelve calendar month period.

We believe that funds generated from operations, together with available capacity 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 and beyond such twelve calendar month period.

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 2023 and beyond through a combination of cash on hand, cash generated from operations, and borrowings on our bank line of credit, as follows:

We expect to meet our cash requirements for 2024 and beyond through a combination of cash on hand, short-term investments, cash generated from operations, and borrowings under our credit facility, as follows:

● Cash on Hand .

As of December 31, 2023, we had $145.0 million in cash and cash equivalents.

● Short-term Investments .

As of December 31, 2023, we had $152.2 million in short-term investments.

● 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 positive cash flow.

● Bank Line of Credit .

As of December 31, 2022, no borrowings were outstanding under our $50.0 million bank line of credit, which is available until March 2025.

● Credit facility .

As of December 31, 2023, no borrowings were outstanding under our $50.0 million credit facility, which is available until March 2025.

Accordingly, our entire line of credit was available for borrowing as of December 31, 2023.

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

As of December 31, 2022, we were in compliance with all of our covenants.

As of December 31, 2023, we were in compliance with the covenants of our credit facility.

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, our cash flows from operations may be substantially affected.

See also related risks listed under “Item 1A.

Risk Factors.”

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 are materially adversely impacted by the developing macroeconomic trends characterized by inflation and increased interest rates, our cash flows from

operations may be substantially affected.

For additional discussion see related risks listed under “Item 1A.

Risk Factors” of this Annual Report on Form 10-K.

Summary Sources and Uses of Cash

The following table summarizes our sources and uses of cash over the last three years (in millions of dollars):

The following table summarizes our sources and uses of cash over the last three years (in millions):

Years Ended December 31,

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Increase in cash and cash equivalents

Cash provided by operating activities was $34.9 million for the year ended December 31, 2022.

Cash flow provided by operations during the year ended December 31, 2022 resulted primarily from $89.2 million of net income and $19.6 million of other non-cash charges added back to net income, including $12.0 million of depreciation and amortization, for the year ended December 31, 2022.

These factors that contributed to the positive inflow of cash from operating activities were partially offset by an increase in accounts receivable of $6.0 million primarily due to an increase in vendor receivables, as well as decreases in accounts payable and accrued expenses and other liabilities of $49.1 million and $14.7 million, respectively.

The five-day increase in DSO is primarily a function of netted products recorded in accounts receivable on a gross basis, while the revenue is recorded on a net basis.

The decreases in accounts payable and accrued expenses and other liabilities were primarily driven by the timing of payments.

Operating cash flow for the year ended December 31, 2021 resulted primarily from cash provided by net income prior to non-cash charges of $69.9 million and increases in account payables and accrued expenses of $32.5 million, primarily due to the timing of payments.

Those inflows of cash from operating activities were partially offset by increases in inventory of $65.7 million for the year ended December 31, 2021.

Cash provided by operating activities was $197.9 million for the year ended December 31, 2023, which resulted primarily from $83.3 million of net income, $18.4 million of other non-cash charges added back to net income (including $12.7 million of depreciation and amortization and $7.0 million of stock-based compensation expense), an $84.5 million decrease in inventory, and a $31.1 million increase in accounts payable.

These factors that contributed to the positive inflow of cash from operating activities were partially offset by a decrease in accrued expenses and other liabilities of $11.8 million and an increase in prepaid expenses and other current assets of $8.5 million.

The decrease in inventory was primarily due to a decrease in the amount of inventory we purchased, combined with the delivery of inventory held associated with the continued fulfillment of orders in 2023 that were in backlog during 2022.

The increase in accounts payable was primarily driven by the timing of payments.

Cash provided by operating activities for the year ended December 31, 2022 resulted primarily from cash provided by net income of $89.2 million and $19.6 million of other non-cash charges added back to net income, including $12.0 million of depreciation and amortization, partially offset by increases in account payable and accrued expenses of $49.1 million and $14.7 million, respectively.

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.

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(3) Represents the accounts payable balance at the end of the period divided by average daily cost of sales for the same three-month period.

The cash conversion cycle was 66 days for the quarter ended December 31, 2022, an increase compared to the cash conversion cycle of 55 days for the quarter ended December 31, 2021, as evidenced in the above cash conversion table.

Cash used in investing activities for the year ended December 31, 2022 consisted of $9.1 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.

Cash used in investing activities for the prior year consisted of $10.3 million of purchases of property and equipment, partially offset by $1.5 million of cash proceeds from life insurance.

Cash used in financing activities decreased for the year ended December 31, 2022 compared to the prior year and consisted primarily of $8.9 million in special dividend payments.

The cash conversion cycle decreased to 51 days for the quarter ended December 31, 2023, compared to 66 days for the quarter ended December 31, 2022, as evidenced in the above cash conversion table.

The increase in DSO is primarily due to increased netted product sales which reduces the revenue, but not the receivable balance.

The decrease in DIO is consistent with the decrease in inventory discussed above.

The increase in DPO is consistent with the increase in accounts payable discussed above.

Cash used in investing activities for the year ended December 31, 2023 consisted of $150.6 million of purchases of short-term U.S.

Government treasury securities and $9.6 million of purchases of property and equipment.

The property and equipment expenditures were primarily for computer equipment and capitalized internally-developed software in connection with investments in our IT infrastructure.

Cash used in investing activities for the prior year consisted of $9.1 million of purchases of property and equipment.

Cash used in financing activities for the year ended December 31, 2023 consisted of $88.2 million of aggregate borrowings and repayments under our credit facility, $5.4 million of treasury repurchases, $8.4 million of dividend payments, $1.1 million of issuances of stock under the 1997 Employee Stock Purchase Plan, and $3.0 million of payroll taxes on stock-based compensation through shares withheld.

In the prior year period, financing activities consisted primarily of $8.9 million in special dividend payments.

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

Bank Line of Credit.

Our bank line of credit extends until March 2025 and is collateralized by our accounts receivable.

Our borrowing capacity is up to $50.0 million at the greatest of (i) the prime rate (7.50% at December 31, 2022), (ii) the federal funds effective rate plus 0.50% per annum and (iii) the one-month London Interbank Offered Rate, or LIBOR, plus 1.00% per annum, provided that the rate shall at no time be less than 0% per annum.

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

Credit facility.

Our credit facility extends until March 2025 and is collateralized by our accounts receivable.

As of December 31, 2023, our borrowing capacity under the credit facility was up to $50.0 million.

Amounts outstanding under this facility bear interest at the greatest of (i) the prime rate (8.50% at December 31, 2023), (ii) the federal funds effective rate plus 0.50% per annum and (iii) the daily Bloomberg Short-Term Bank Yield Index, or BSBY Rate, plus 1.00% per annum, provided that the rate shall at no time be less than 0% per annum.

In addition, we have the option to increase our borrowing capacity under the credit facility up to an additional $30.0 million provided that we meet certain additional borrowing requirements and obtain the consent of the administrative agent.

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

We did not have any borrowings outstanding under the credit facility as of December 31, 2023.

In December of 2021, we entered into an amendment to our credit facility to, among other things, extend the maturity date to March 31, 2025, at which time any amounts outstanding become due.

See “Part II – Item 9b.

Other Information – Third Amendment to Third Amended and Restated Credit and Security Agreement” for additional information.

Cash receipts are automatically applied against any outstanding borrowings.

Any excess cash on account may either remain on account to generate earned credits to offset up to 100% of cash management fees, or may be invested in short-term qualified investments.

Borrowings under the line of credit are classified as current.

Borrowings under the line of credit are classified as current in our consolidated balance sheet.

As of December 31, 2023, the entire $50.0 million facility was available for borrowing.

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Certain leases require us to pay real estate taxes, insurance, and common area maintenance charges.

Properties” of this Annual Report on Form 10-K for additional information regarding our operating leases.

Factors Affecting Sources of Liquidity

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The key factors affecting our internally generated funds are our ability to manage costs and fully achieve our operating efficiencies, timely collection of our customer receivables, and management of our inventory levels.

Bank Line of Credit.

Our bank line of credit extends until March 2025 and is collateralized by our accounts receivable.

Credit facility.

Our credit facility extends until March 2025 and is collateralized by our accounts receivable.

As of December 31, 2023, the entire $50.0 million facility was available for borrowing.

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This credit facility contains two financial tests:

● The funded debt ratio (defined as the average outstanding advances under the line for the quarter, divided by the consolidated Adjusted EBITDA for the trailing four quarters) must not be more than 2.0 to 1.0.

We didn’t have any outstanding borrowings under the credit facility during the fourth quarter of 2022, and accordingly, the funded debt ratio did not limit potential borrowings as of December 31, 2022.

Future decreases in our consolidated Adjusted EBITDA, however, could limit our potential borrowings under the line of credit.

● Minimum Consolidated Net Worth must be at least $346.7 million, plus 50% of consolidated net income for each quarter.

Such amount was calculated at December 31, 2022 as $561.4 million, whereas our actual consolidated stockholders’ equity on such date was $766.2 million.

● The funded debt ratio (defined as the average outstanding advances under the line for the quarter, divided by the consolidated trailing twelve months Adjusted Earnings Before Interest Expense, Taxes, Depreciation, Amortization,

and Special Charges, or Adjusted EBITDA, for the trailing four quarters) must not be more than 2.0 to 1.0.

We did not have any outstanding borrowings under the credit facility during the fourth quarter of 2023, and accordingly, the funded debt ratio did not limit potential borrowings as of December 31, 2023.

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

● 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 $603.1 million at December 31, 2023, whereas our actual consolidated stockholders’ equity at that date was $840.8 million.

Capital Markets.

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Customers may purchase perpetual licenses or enter into subscriptions to the licensed software.

We are the principal in these transactions and recognize revenue for the on-premise license at the point in time when the software is made available to the customer and the commencement of the term of the software license or when the renewal term begins, as applicable.

We are the principal in these

transactions and recognize revenue for the on-premise license at the point in time when the software is made available to the customer and the commencement of the term of the software license or when the renewal term begins, as applicable.

For certain on-premise licenses for security software, the customer derives substantially all of the benefit from these arrangements through the third-party delivered software maintenance, which provides software updates and other support services.

We do not have control over the delivery of these performance obligations, and accordingly we are the agent in

these transactions.

We do not have control over the delivery of these performance obligations, and accordingly we are the agent in these transactions.

We recognize revenue for security software net of the related cost of sales at the point in time when our vendor and customer accept the terms and conditions in the sales arrangement.

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title is passed directly from the supplier to our customer.

Amounts recognized on a net basis included in net sales for such third-party services and agency sales transactions were $56.2 million, $50.0 million, and $47.8 million for the years ended December 31, 2022, 2021, and 2020, respectively.

Amounts recognized on a net basis included in net sales for such third-party services, agency sales, and off-premise software transactions were $141.8 million, $127.5 million, and $103.5 million for the years ended December 31, 2023, 2022, and 2021, respectively.

Certain software sales include on-premise licenses that are combined with software maintenance.

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We record these agency fees as a component of net sales as earned and there is no corresponding cost of sales amount.

In certain instances, we invoice the customer directly under an EA and accounts for the individual items sold based on the nature of each item.

In certain instances, we invoice the customer directly under an EA and account for the individual items sold based on the nature of each item.

Our vendors typically dictate how the EA will be sold to the customer.

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All amounts billed to a customer in a sales transaction related to shipping and handling, if any, represent revenues earned for the goods provided, and these amounts have been included in net sales.

Costs related to shipping and handling billing are classified as cost of sales.

Costs related to shipping and handling

billing are classified as cost of sales.

Sales are reported net of sales, use, or other transaction taxes that are collected from customers and remitted to taxing authorities.

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Determining whether we are the agent or the principal and whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.

We estimate the standalone selling price, or SSP, for each distinct performance obligation when a single arrangement contains multiple performance obligations and the fulfillment occurs at different points of times.

We maximize the use of observable inputs in the determination of the estimate for SSP for the items that we do not sell separately, including on-premise licenses sold with software maintenance, and IT products sold with ESPs.

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Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and customers’ current creditworthiness.

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and current creditworthiness.

Our allowance for credit losses is generally computed by (1) applying specific percentage reserves on accounts that are past due, and (2) specifically reserving for customers known to be in financial difficulty.

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Our cash flows would be impacted to the extent that receivables could not be collected.

As of December 31, 2022, our accounts receivable aging improved from December 31, 2021, reflecting the general improvement in the economic environment from the COVID-19 pandemic in the calendar years ended on December 31, 2021 and 2020, respectively.

We collected a significant amount of these older at-risk invoices during the calendar year ended December 31, 2022.

Though our bad debt expense was $3.3 million for both the twelve months ended December 31, 2022 and 2021, respectively, the related risk on collections is different as of December 31, 2022.

The collection risk assessments as of December 31, 2022 were consistent with the volume of invoices associated with the increased revenue recognized during the twelve months then ended.

We continued to improve on our collection efforts in 2023.

Our bad debt expense for the year ended December 31, 2023 decreased to $1.8 million, compared to $3.3 million for the year ended December 31, 2022.

In addition to accounts receivable from customers, we record receivables from our vendors/suppliers for cooperative advertising, price protection, supplier reimbursements, rebates, and other similar arrangements.

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Write offs of customer and vendor receivables totaled $3.3 million in 2023 and $2.8 million in 2022.

Considerable estimates are used in assessing the ultimate realization of customer receivables and vendor/supplier receivables, including reviewing the financial stability of a customer, vendor information, and gauging current market

If our evaluations are incorrect, we may incur additional charges in the future on our consolidated statements of income.

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Increased obsolescence or decreased customer demand beyond management’s expectations could require additional provisions, which could negatively impact our earnings.

We recorded obsolescence charges of $3.1 million, $2.7 million, and $1.7 million for the years ended 2022, 2021 and 2020, respectively.

Our provision for inventory obsolescence was $2.4 million, $4.3 million, and $3.5 million for the years ended December 31, 2023, 2022, and 2021, respectively.

We recorded obsolescence charges of $2.8 million, $3.3 million, and $3.0 million for the years ended December 31, 2023, 2022 and 2021, respectively.

Historically, there have been no unusual charges precipitated by specific technological or forecast issues.

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In 2023 and 2022, we performed a “step 0” qualitative analysis.

ASC 350— Intangible – Goodwill and Other states that an entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill.

Accounting Standards Codification 350— Intangible – Goodwill and Other states that an entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill.

This analysis allows the Company to consider qualitative factors that might impact the carrying amount of its goodwill to determine whether a more detailed quantitative analysis would be necessary.

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While we believe that our conclusions are reasonable, different assumptions could materially affect our valuations and result in impairment charges against the carrying values of those remaining assets in our Enterprise Solutions and Business Solutions segments.

However, at December 31, 2022, a 10 percent decline in projected cash flows or 10 percent increase in the discount rate would not result in an impairment.

Please see Note 4, “Goodwill and Other Intangible Assets” to the Consolidated Financial Statements included in Item 8 of Part II of this report for a discussion of the significant assumptions used in our annual impairment test analysis.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis