PC Connection Inc (CNXN) 2014 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the third-quarter 2014 PC Connection, Inc. earnings conference call. My name is Liz and I will be the coordinator for today. (Operator Instructions)

As a reminder, this conference call is the property of PC Connection and may not be recorded or rebroadcast without specific permission from the Company.

On the call today is Tim McGrath, President and Chief Executive Officer; and Joe Driscoll, Chief Financial Officer.

Any statements or references made during the conference call that are not statements of historical fact may be deemed to be forward-looking statements. Various remarks that management may make about the Company's future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factor section of the Company's annual report on Form 10-K for the year ended December 31, 2013, which is on file with the Securities and Exchange Commission as well as in other documents that the Company files with the Commission from time to time.

In addition, any forward-looking statements represent management's views as of today and should not be relied upon as representing views as of any subsequent date. While the Company may elect to update forward-looking statements at some point in the future, the Company specifically disclaims any obligation to do so, even if estimates change and therefore, you should not rely on these forward-looking statements as representing views as of any date subsequent to today.

If you have not seen the press release, you can contact Janice Rush at 603-683-2322 and she will email a copy to you. Today's call is being webcast and both the press release and webcast will be available at the investor and media center page at PC Connection's website.

I would now like to turn the call over to Tim McGrath. Please proceed, sir.

Good afternoon, everyone, and thank you for joining us today to review the Company's third-quarter financial results. We are pleased with our strong third-quarter performance. Our sales, net income, and earnings per share were the highest quarterly results in the Company's history. Net sales grew by 10.2%.

This was our third consecutive quarter of double-digit growth. IT spending trends by our business customers continued to be strong and our education business had another excellent growth quarter, for both K-12 and higher education. We grew earnings faster than sales, as net income and diluted earnings per share both increased by 15% in the quarter.

We continue to execute our core growth strategies to deliver a broad spectrum of IT solutions. Our goals are to increase market share, invest in a higher margin technical solutions capabilities, enhance operational efficiencies, and maximize growth opportunities in targeted vertical markets.

As we review our results, please note that unless otherwise stated, all of our third-quarter 2014 comparisons are being made against the third quarter of 2013. Consolidated net sales increased year over year by $59 million, or 10.2%, to $640 million.

Gross profit dollars increased by 9% to $84 million. Gross margin was slightly lower than the prior year at 13.1%. The product mix shift to lower margin notebooks and desktops was partially offset by strong performance in software and servers, which are higher-margin categories.

Net income for the quarter increased by 15% to $12.2 million and diluted earnings per share increased from $0.40 to $0.46. Earnings grew faster than the rate of sales growth due to the leveraging of our fixed costs over higher net sales. Operating income as a percentage of sales increased to 3.2% in Q3 versus 3% in the prior year.

And now I'll turn the call over to Joe Driscoll to discuss the results of our business segment and financial highlights. Joe?

Thanks, Tim. Sales for our SMB segment, which serves small- to medium-size businesses, increased by 8.1% to $254 million, with double-digit percentage increases in the notebook and desktop server categories.

Gross profit dollars for SMB increased by 4%; however, gross margin decreased by 64 basis points to 14.9%. The decrease in gross margin was due to increased demand for lower margin products, such as notebooks and desktops.

Sales by our large account segment increased by 4.6% to $202 million, led by 31% sales growth in software. Total gross profit dollars grew by 13% and gross margin increased significantly from 12.1% to 13.1%.Our overall commercial sales, which is the combination of our SMB and large account segments, grew by 7%.

Quarterly sales in the public sector segment, which includes sales to government and education customers, increased by 21%. Sales to state and local governments and education customers increased by 30%, whereas sales to the federal government were down 3%.

Gross profit dollars for the public sector segment increased by 16% and gross margin decreased from 10.8% to 10.4%. The decrease in margin is attributable to the significant increase in sales of lower margin notebooks and desktops during the quarter.

Our consolidated SG&A expense increased by $4.2 million. However, SG&A as a percentage of net sales decreased by 28 basis points. Variable SG&A accounted for a significant part of the increase in dollars due to higher net sales.

Fixed SG&A expense increased due to planned additions to our sales teams and additions to our technical resources, including engineers focused on datacenter and cloud solutions. In addition, SG&A expense in the third quarter included approximately $500,000 of depreciation related to our Customer Master Data Management project, which was put into service in Q4 2013.

Overall, our financial performance was solid. In addition to increasing EPS to $0.46 per share, we also increased our trailing 12-month adjusted EBITDA to $77 million. For the first nine months of 2014, our results have been strong, with revenues up 11.5% and net income up 19%.

Our balance sheet is also strong, as our cash balance totaled $66 million as of September 30, 2014. We regularly assess how to best deploy our excess cash and our goal is to maximize shareholder value while maintaining financial flexibility.

I will now turn the call back over to Tim to discuss current market trends.

Thanks, Joe. The overall IT market continues to undergo significant changes. In the last month, both HP and Symantec have announced plans to break into two companies and Lenovo completed the acquisition of IBM's x86 server business. These industry dynamics may result in changes or reductions in certain partner funding programs.

In order to maximize channel incentives and our overall profitability, we need to continue to transform our business and invest in emerging technologies, which will increase our SG&A expenses.

As we look out into Q4, we believe that sales growth will return to levels that are consistent with industry expectations. We experienced substantial growth in the first three quarters from several areas that are not likely to continue to grow at the same rate in Q4, including the expiration of Windows XP and the increase in project rollouts.

In addition to these factors, our customers in all sales segments continue to research new, disruptive technologies for their datacenters and are also evaluating cloud alternatives, which has resulted in lengthening or -- lengthening all, excuse me, purchasing decisions in some complex solution categories.

Industry experts have projected overall IT growth rates in the low to mid single-digit range for 2014. Therefore, we believe that the current consensus estimates for the Company's performance for Q4 2014 are reasonable.

Looking ahead to next year, our expectations for the first nine months of 2012 (sic - 2015) are that our revenues will grow in the low-single-digit range. Industry experts have reduced their growth projections and are now predicting overall growth in the 3% range and we will be comparing against the 11.5% growth we've achieved thus far in 2014.

As a reminder, 2014 includes the increased activity from the windows XP expiration, which is not expected to have any impact in 2015. In addition, IDC currently projects a 7% decline in the education space for 2015.

Our SLED business is up almost 26% for the first nine months of 2014. So it will be challenging to grow the business in 2015, given IDCs outlook for the education market.

As changes in the market continue to unfold, we feel it is critical that we manage our growth appropriately while keeping our balance sheet strong. We also believe that our balanced portfolio of customers, suppliers, products, and solutions has helped us to deliver solid results. Our goal is to continue to deliver sustained and consistent performance.

We will now entertain your questions. Operator?

(Operator Instructions) Prab Gowrisankaran, Canaccord.

Congrats on a strong quarter. Yes, I had a couple of questions on the overall [or the] industry growth. You talked about maybe low to mid single-digit growth. I know in for 2015, you said IT forecast is 3%.

Do you in your low single-digit revenue growth expectation, is it more are you expecting to accelerate the emerging technologies to offset the expected slowdown in the rest of the areas? If you can add any color to that forecast that you provided.

Clearly, we are making investments in advanced technologies and we do expect that we will have the opportunity to engage our customers in more meaningful datacenter conversations next year as we look at the expiration of Windows 2003. So I think, clearly, that will open up some opportunities.

So we are optimistic on some of the advanced technologies, but overall, I think the blended estimates that we are seeing from IDC Gartner and from your industry peers are reasonable. So overall, I think they're pretty good.

Okay. And you do expect that even off this higher base, like the first three quarters have been really high, do you still expect a year-on-year low single-digit growth from this higher base in 2015?

Yes. It will probably be in the low single-digits, just given that we are comping against big numbers this year. We are up 11.5% for the first nine months of this year. So it will be interesting growing next year, especially if the education vertical starts slowing down. That has been a real big winner for us this year.

Okay. The other question I had was in terms of your goal to expand advanced technologies. Do you see that happening through organic growth or through acquisitions and what are your thoughts on the use of cash that you have?

Well, there are a couple of parts to the question. So to begin with, we think we have a solid strategy and the right team in place and we continue to make investments in the advanced technology arena. So we don't feel any pressure to do an acquisition.

With that said, we remain open, should an acquisition come along that could be a tuck-in that would be accretive and that would expand us in one of our critical categories. So I think we are open to that. We are very conscientious of our cash and we are always looking at alternatives.

Yes, so in the last three years, we have done special dividends each year. We are always looking at acquisitions. We know we are looking at other possible uses of our cash.

So we are evaluating everything right now. No specific plans at this time to move in any specific direction. But we are looking at everything right now.

Okay, great. Thanks for take my questions.

Jeff Martin, ROTH Capital Partners.

Could you shed some light into the 7% decline that IDT projects in education? Is that because we are seeing a nice lift to 9 months this year or is there something else behind that?

Well, I think much of the drivers in the education space, many of them have already happened. I think the common core upgrades have -- are pretty much behind us. I think there is some tailwind we can expect to see from some of the E-rate changes.

But overall, I think the high growth this year and the fact that many of the project upgrades have been done, I think that is really the main driver of their decline.

Okay. And then are you seeing any uplift in demand on the server side due to the Windows expiration or is it still too early for that?

I think -- it is an interesting question and we have been looking at it closely. We are pretty confident that that expiration is going to give us the opportunity to have really meaningful conversations with our customers about building the optimum datacenter for the future.

But we are also confident that that is going to open up a discussion in a number of areas and that is much more complex than what we just went through with the Windows XP expiration. So we are watching that closely, but there is nothing that we have seen that would be significant in the quarter. And I wouldn't forecast anything significant for Q4.

And then on the advanced technology side, could you give some perspective on where you are at today or where you maybe you started the year and what kind of additions you are talking about in terms of capacity? And what kind of learning curve there is for advanced technology personnel?

Yes. Our internal goal is that 50% of our revenue come from what we would consider to be advanced technologies. This year, we have actually had a mix shift to notebooks and desktops because of Windows XP and some of these other factors.

So we are hovering around that 40% mix right now. We are still doing very well with many of our advanced technology categories, especially software.

And in terms of how do we grow that number, we really are looking to add people. That is really what we look to do to grow that number is to add more technical people to our headcount. And those people are the ones that can have the complex conversations with our customers, get us more deeply in the datacenter, and so we are going to continue to hire those people.

And in addition, we also are very conscientious of the infrastructure and the efficiencies required, so we are continually improving our own tools. We have a service management tool web [spot] that we have been investing in. We are continuing to make upgrades behind-the-scenes that will ultimately make the teams more efficient.

Okay. As you transition to 50% advanced technologies, what is the gross margin profile of the business look like at that point?

Yes, so really, the advanced technology business is our higher margin. If you look at some of our competitors out there that are heavily advanced technology, you can see gross margins in the high teens or even the 20%s, but we do have a big mix right now, still, of notebooks and things like that.

So I think you are going to see a gradual evolution in our gross margin over a number of years to tick up 10 basis points, 20 basis points a year as we continue to move in that direction. But we can get much higher than where we are today.

Okay, great. And then last question, any feel for market share gains? Although it may be gradual, how do you feel you are faring there?

We are pretty confident that we are taking market share. Right now, we think we are growing ahead of the market. It is a pretty vast market, but the latest estimates that we have seen, but we think that the market in Q3 might have grown in our channel at around 7%. And we know we are ahead of that. And from what we've seen from some of our suppliers, we are confident that we are taking market share.

Great. Thanks, guys. Congrats on the quarter.

(Operator Instructions) Scott Tilghman, B. Riley.

Good afternoon. Two areas I wanted to focus on. First, just getting a little bit more color on the mix of business in third quarter. What was better spending, what was some XP carryover, what was one time? Just to understand the strength in the revenue number.

Thanks, Scott. I will start. We had really strong growth in the quarter from software and some -- we had strong growth in servers and then of course, very strong growth in the notebook category.

I don't think much of that was about Windows XP. I think that tailwind really has expired. That was behind us. I think we did see some pent-up demand for projects. And of course, we had terrific help from our public sector business, specifically the state and local business. They had really strong growth in both notebooks and Chromebooks.

Yes, that is really the main factors of mix in the quarter. Notebooks, servers, software were the strong components of it.

Right. I was just trying to get my hands around what was potential carryover from XP versus what was new business not tied to that.

Yes, we saw almost zero, to be honest with you, or a very insignificant number in Q3 from Windows XP. For us, it seems to be concentrated in the first six months of this year.

The second thing I wanted to ask about is focus areas for investment. And you've touched on this a little bit with a question about acquisition. But wondering if you could remind us what areas you feel you are underserved or don't have the expertise that you would like to have, what areas are of interest that maybe you are not involved in at all?

And then related to that, how much of a pipeline of either personnel or small business tuck-in opportunities are you seeing?

If we gave you the impression that we are understaffed or underserved in what we will call our practice areas, I think we are actually pretty strong. We want to continue to invest. We've come a long way. We have got a long way to go. So it really is a journey.

We are seeing some changes out there in the competitive landscape. Several new and disruptive technologies are coming into play. And so our challenge to make sure that we are ahead of those changes so that we can advise and counsel our customer base as to what is best for them in solving their business problems with IT.

So an example might be we are seeing lots of changes and lots of disruption in the storage space. And we are seeing a lot of companies who want to have discussions about moving workloads off-premise.

So those are the examples -- or example -- that we would want to make sure that we were continuing to invest in. So when you net that out, it really is the converged datacenter. So that is the networking security, storage, server arena.

In the software space, we have made big investments. We are showing great growth there. Our software is growing really well. But we are going to continue to grow there -- as we move into the future, more of the datacenter is going to be software defined, so we will continue to add resources there.

With the multitude of regional players, are you seeing any opportunity to take them out to acquire them or are they basically giving up market share and it is doing and your large competitors grow?

Yes, I think for the time being, what we are focused on is taking market share. It hasn't quite make financial sense to pay a lot of money for a local guy or regional guy based on what people's expectations are currently.

But right now, we are focused on taking market share. We are certainly open to acquisitions, but we really need to convince ourselves it is going to be accretive in year one. So we are going to continue to take market share and we are going to continue to look at acquiring and maybe we will do some of both.

Great, thank you.

I'm showing no further questions on the phone lines at this time. I would like to turn the call back to Tim McGrath for closing remarks.

Well, thank you, operator. We are encouraged with PC Connection's strong performance this quarter. We had solid execution against all three of our sale segments, reinforcing the strength and diversity of our business model.

As a national solution provider, our goal is to consistently invest in more complex solution capabilities while delivering solid financial performance. And we were able to accomplish that goal in Q3 with 10% increase and a 15% increase in sales and earnings in a rapidly changing industry.

We believe the team and the strategy that we have in place position PC Connection well to gain market share and increase long-term shareholder value. And I would like to thank all of our customers, vendor partners, and shareholders for their continued support and our dedicated coworkers for their efforts.

I would also like to thank those of you listening to our call this afternoon. Your time and interest in PC Connection are appreciated. Have a great evening.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.