PC Connection Inc (CNXN) 2014 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the fourth-quarter 2014 PC Connection, Inc. earnings conference call. My name is Jonathan and I will be the coordinator for today. At this time all participants are in a listen-only mode. Following the prepared remarks there will be a question-and-answer session. As a reminder, this conference call is the property of PC Connection and may not be recorded or rebroadcasted 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, 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 those forward-looking statements as a result of various important factors including those disclosed in the risk factors 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 view as of today and should not be relied upon as representing views 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 of any date subsequent to today.

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

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

Thank you. Good afternoon everyone and thank you for joining us today to review the Company's fourth-quarter and full-year financial results.

We are pleased with our strong fourth-quarter and full-year performance. We had another solid revenue quarter with 9% growth. For the full-year 2014, revenue growth was 11%. 2014 was a great year for the industry and for PC Connection. Our industry had a tailwind from the expiration of Windows XP and from the robust overall spending by corporate and educational customers.

We benefited from those trends and we were able to grow significantly faster than the overall market by taking market share from the competition and the VAR community.

We grew earnings faster than sales as net income and diluted earnings per share increased by 21% and 22% in the quarter respectively.

For the full year, earnings per share grew from $1.35 in 2013 to $1.61 in 2014. We continue to execute our core growth strategies to deliver a broad spectrum of IT solutions. Our goal is to increase market share, invest in higher margin technical solution 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 fourth quarter 2014 comparisons are being made against the fourth quarter of 2013.

Consolidated net sales increased year-over-year by $52 million or 9% to $631 million. Gross profit dollars in the quarter increased by 10% to $83 million. Gross margin was slightly higher than the prior year at 13.2%.

We had strong performance in software, storage, servers and networking which are higher-margin categories. Net income for the quarter increased by 21% to $11.9 million and diluted earnings per share increased from $0.37 to $0.45. 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 percent of sales increased to 3.2% in Q4 versus 2.8% in the prior year.

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

Thanks, Tim. Sales for our SMB segment which serves small- to medium-sized businesses increased by 9.2% to $262 million led by 23% growth in notebooks, the largest SMB category. Gross profit dollars for SMB increased by 8.6%. However, gross margin slightly decreased by 9 basis points to 15.2%. The decrease in gross margin was due to increased demand for lower margin products such as notebooks.

Sales by our large account segment increased by 3.5% to $226 million led by 32% sales growth in storage and 22% sales growth in software. Total gross profit dollars grew by 6% and gross margin increased from 11.4% to 11.6%. Our overall commercial sales which is the combination of our SMB and large account segments grew by 6.5%.

Quarterly sales in the public sector segment which include sales to government and education customers increased by 19%. Sales to state and local governments and education customers increased by 18% whereas sales to the federal government increased by 19%.

Gross profit dollars for the public sector segment increased by 20% and gross margin increased from 11.7% to 11.9% in Q4. The increase in margin is attributable to the significant increase in sales of networking products during the quarter.

Our SG&A expense increased by $3.7 million. However, SG&A as a percentage of net sales improved by 26 basis points. Variable SG&A accounted for a significant part of the increase in dollars due to higher net sales. Fixed SG&A increased due to planned additions to our sales teams and additions to our technical resources including engineers focused on datacenter and cloud solutions.

In 2015, we will be moving into a new distribution center in Wilmington, Ohio. This facility will be approximately 270,000 square feet and will replace two smaller facilities we currently operate in Wilmington. The new DC will greatly expand our capacity to do advanced configurations which is a rapidly expanding segment of our business.

In 2015, we will incur some duplicate costs while we ramp up the new DC since our existing facilities have leases that expire near the end of the year. We anticipate the transition to increase SG&A by just over $1 million in 2015 or approximately $0.03 per share spread over Q2 through Q4. In 2016 and beyond, we believe the new DC will generate significant efficiencies in our operations.

Overall our financial performance was solid. In addition to increasing EPS to $0.45 per share, we also increased our trailing 12-month adjusted EBITDA to $80 million. Our results have been strong for 2014 with revenues up 10.9% and net income up 19.6%.

Our balance sheet is also strong as our cash balance totaled $61 million as of December 31, 2014. We paid a $0.40 special dividend in Q4 which returned $10.5 million to shareholders. This is the fourth year in a row that we have done a special dividend for a total of more than $40 million in dividend payments.

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 2014 both HP and Symantec announced plans to break into two companies and Lenovo completed the acquisition of IBM's x86 server business. These changes along with others with other new disruptive industry dynamics may result in changes or possibly 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 people and emerging technologies which will increase our SG&A expenses.

In addition, as Joe mentioned earlier, we will have the additional SG&A of just over $1 million in 2015 from the transition to our new distribution and advanced configuration center. As we look out to 2015 we believe that sales growth will return to levels that are consistent with industry expectations.

We experienced significant growth in 2014 from several areas that are not likely to continue to grow at the same rate in 2015 including the expiration of Windows XP, the increase in education business from the implementation of the Common Core standards and an increase in corporate project rollouts.

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

Our expectations are that revenues will grow in the low single-digit range in 2015. Industry experts are now predicting overall IT spending growth in the 3% range and we will be comparing against the 11% growth that we achieved in 2014. Given this revenue outlook, we expect that earnings per share growth will be in the mid single-digit range in 2015 before the additional costs related to the new distribution and advanced configuration center.

As changes in the markets continue to unfold, we feel it is critical that we manage our growth appropriately while keeping our balance sheet strong. We 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). Prabhakar Gowrisankaran, Canaccord.

Congrats on the strong quarter. Just a couple of questions. One on the growth rates that you expect to the low single digits, are you expecting to grow faster than 3%? And the other thing you have commented on was lengthening sales cycles in some segments, if you can add a little bit more color that would be great.

Our outlook for 2015 is consistent with what we are seeing for industry growth projections and we are saying that because there are a number of forces at play. We have discussed some of them but as you know, the Windows server will certainly -- the expiration of Windows server will present an opportunity to have higher level datacenter discussions but those types of discussions can easily lengthen sales cycles especially when compared to the more velocity products like we saw with the expiration of Windows XP.

So it is more of a complex solution set. The discussions are more advanced and they often take a longer time. So yes, our growth rates are really consistent with what the industry is saying right now.

Really the first six months of 2015 is really going to be we think a challenging growth period just because of the big comps we had. Windows XP really impacted the first six months of 2014. So as we look out to 2015, it is really the first six months that we see the need to overcome the big comps from last year but we still feel very good about the business. It is just the comps we are going up against.

The second question I had was just in terms of the notebook benefit that you saw and SMB, is that like year-end budget flush thing or do you expect it to continue? Are you seeing a recovery there? Then you saw pretty strong net comm in public sector. What do you see the trends there?

So it is interesting, we are seeing a lot of strength in our notebook category. Clearly many of our customers are moving into what we consider more of the third platform technologies, mobile, social, cloud, big data and security and that is driving growth but we want to underscore that a lot of the notebook and some of the desktop growth that happened in 2014 especially in the first two quarters was about the Windows XP expiration. So that is a component that we don't think will repeat.

We do think there is still some good opportunity out there. There is some pent-up project demand. The funnels look okay but we are not going to see the growth rates in notebooks that we saw last year.

Then in terms of networking, you specifically ask about the public sector. We had several excellent projects in Q4 really spread across the public sector, there were some education customers as well as some government accounts and we expect networking to continue to be a good category for us in the future.

Okay, great. Thanks a lot.

Jeff Martin, ROTH Capital Partners.

Could you give us an update on the progress you are making in advanced technologies? I know your goal is to get to 50% of revenue from those types of sales. An update would be helpful.

We are excited about the direction we are going in. We are making a number of changes internally and a number of investments but we also saw in Q4 a nice little spike up in the advanced technology sector consistent with more of the datacenter type discussions that we have been having. So Q4 was our best quarter to date in advanced technologies and that did jump up a little bit from Q2 and Q3 because again in those quarters we had the Windows XP kind of velocity business.

Okay. And then what is your current view on acquisitions? Are you always looking, is there anything interesting out there, specific areas that would help maybe further you along in the advanced technologies? What are you thinking about acquisitions these days?

Jeff, that is an interesting question. To begin with, we feel that we have the right team, the right strategies in place so that we don't feel the need to do anything. However, we are open to opportunities. We think it is a consolidating market and clearly we are open to opportunities that would be accretive opportunities that would give us round out a solution set that we might need or a tuck-in, would certainly be interesting to us.

And then as you are looking out further this year, are there specific areas where you expect either a pickup in demand or a continuation of demand just walking through your various categories would be helpful.

So, Jeff, that is a terrific question because clearly there is going to be an opportunity and if you look out at the drivers of growth, we are seeing an opportunity with software, seeing an opportunity with security and clearly with the Windows server expiration, there is an opportunity but that is against a backdrop of a myriad of alternatives, a lot of disruptive technologies, workloads being moved off premise to the cloud. So there is an opportunity but we are going to have to go execute against our strategy and make sure that we are guiding our customers through these complex and changing times.

Okay. You mentioned two things that are going to affect SG&A this year, one being the datacenter, or the distribution center, sorry. The other being the investment in emerging technologies. Are you able to quantify the latter and give some timing on the investment there?

So you should see a similar kind of ramp in -- when we say investments in emerging technologies, that is really hiring people, really hiring more engineers who can help us sell more advanced solutions. So that is the primary item that is going to impact our SG&A. So we are looking to add these people all the time. We don't have a specific dollar amount other than we are constantly looking to recruit new engineers who can help us in that area but it will be several million dollars worth of SG&A in 2015 if you want a round number.

Okay. You have been making those investments over the past couple of years as well though, is that right?

That is correct. It is really a continuation of what we have been doing the last several years where we are adding a couple of million dollars worth of additional headcount expense to sort of the technical areas.

Jeff, I want to just call out the fact that it is a tribute to the team that we have. When we talk about presale technical consulting and the ability to deliver consulting services to help our customers solve their challenges with technology, we've got a great team in place but we are going to continue to add to that team and to continue to augment our business in that area.

Final question on the competition in the VAR community. You are taking share. Is there anything specifically going on within the VAR community or the competition that is leading to that share or is it just execution on your part?

What we are seeing there, we are just looking at growth rates and exiting the year at about 11% growth rate with the growth rates that we are seeing from some of the public competitors and what we are seeing with some of the VAR community, we think in most cases we are growing a little faster than some of them. So we know we are taking share there. We are growing faster than the IT market.

A lot of the smaller players in our space really don't have the end-to-end solutions that we have so we can sell everything from books and printers on one end all of the way up through datacenter solutions on the more complex end. So what we are finding is that the smaller players out there really don't have that end-to-end capability and customers are demanding that more and more from their suppliers.

Great. Thanks for taking my questions.

Rich Kugele, Needham & Company.

Thank you. Good afternoon. Just two quick ones for me. First, and you somewhat addressed it just in the last question, clearly you have been gaining some share but beyond that, the ability to grow beyond the market growth rate, are there adjacencies that you are trying to target beyond what has been traction in the most recent quarters?

Secondly, in a different vein on the server side, if we do see a pickup in Windows server 2003 refresh, does that typically pull through other products with it and is there any type of rule of thumb that you generally have for how it pulls through versus the PC where you maybe only get like a case or something? Is there a pull through ratio for other higher end components like software and networking and storage?

So we do think, I will answer that in reverse order. I think there is a pretty strong ecosystem around the server software and there are a number of components that could easily pull into that or could go the other direction and the process could be moved off premise. In addition to making the decision to really upgrade your server software, you are probably going to expand that and just look at what is the optimum datacenter strategy and that would include a myriad of products and a number of alternatives that range from as I mentioned, from cloud to virtualization to more of an infrastructure upgrade that would be server storage and networking along with the software. So you have a big ecosystem but also a big question mark. We have got to go deliver and execute against that opportunity.

In terms of other areas of growth, I think that was your first question.

We are, internally we are focused on four vertical markets that were driving growth in 2015. The healthcare vertical which is healthcare now is over a $400 million business for us, the financial and banking vertical, the retail vertical with all the changes that are happening there, the Internet of Things and the energy vertical. So if you consider our public sector business to be a subsidiary in addition to that, we are very focused on driving growth in these four verticals.

And then finally, the other big focus area is getting better utilization from the investments that we have made in the [MDM] and our analytic and predictive software capabilities. We have made big investments there and we are really confident that is going to drive a good return and some dividends for us.

Okay, that is helpful. Thank you.

[Adam Tindall], Raymond James.

Thanks. This is Adam in for Brian. Just wanted to touch on margins coming into 2015, we talk a lot about the big deceleration in PCs and you mentioned strong software server storage and networking. Can you talk about gross margin change into 2015 and potential expansion there?

Yes, really for us gross margin improvement is going to come from getting better at selling more advanced technologies. So as we sell more datacenter, more products in that world, our margins should increase as the mix increases.

So what you saw in 2014 was you saw kind of a flattening out of margin year-over-year. We had a big mix that shifted more toward sort of the notebook category. So as we move forward, we expect that gross margins will increase. We may not have the same sales growth percentage that we achieved in 2014 but on sort of lesser percentage sales growth we think the gross margins should be better as our mix improves.

All right, thanks. And then one last, you had mentioned a little bit on vendor incentives. Can you maybe talk about the environment there and we have been hearing things about large vendors looking to go direct, any commentary around that?

There is really nothing specific. I just think that with all of the changes in the industry that always presents kind of a question mark. So we pointed to a number of the changes that are happening but we really don't have anything definitive. We are not particularly concerned about any vendor or their backend programs but feel it is prudent to point out that with all of the changes happening, that certainly was in the realm of possibilities.

Generally speaking the vendors will pay you more if you sell their most advanced technologies, their most current product lines. So the better we get at selling the most advanced technologies, the better the backend dollars are going to be. That is sort of an ongoing process for us to have the right technical resources, to have the right training for our people, etc.

Makes sense. Thanks, guys.

Scott Tilghman, B. Riley.

Thanks. Good afternoon. I wanted to follow-up on the last question. You had talked about some concerns on partner funding into the back half of the year. Did those play out and if so, can you quantify what type of impact they had on margins?

So year over year 2014 versus 2013, we were relatively flat as a percent of sales -- our overall vendor funding. Within the number there were many vendors that were up and many vendors that were down but when you throw it all together we kind of came out fairly reasonably well compared to 2013.

So I think you are going to continue to see that some vendors are going to offer more incentives going forward and some are going to offer less but right now we are projecting it to be relatively flat as a percent of sales.

That is helpful. I wanted to circle back to one of the earlier questions. You talked about market share opportunities being an end-to-end solution provider. Specifically I wanted to ask about all the various disruptions that are occurring and whether you see those predominantly as a challenge or predominantly as an opportunity over the next 12 to 18 months?

I think the answer is a little of both. Clearly there is an opportunity so we think about more of the legacy suppliers, call that the second platform if you will. Some of their products are going to be in slight recession. However when we look at some of the newer technologies and more of the third platform technologies, some of those are really going to grow and we are seeing a good adoption for newer, we will call them disruptive technologies in the advanced configuration and technology space. So some of the newer names are really coming on fast.

That is helpful. And then just on a related note, do you feel like there are any holes that you need to fill in the near term? Obviously you are bringing on board some other folks with different levels of expertise but are there any specific holes that you would like to fill in the short term?

There is nothing immediate that comes to mind. We are opportunistic but right now I do think we have the right team in place and the right strategy in place and we will keep our eyes open for market opportunities.

Great. Thank you.

(Operator Instructions). This does conclude the question-and-answer session of today's program. I would like to hand the program back for any further remarks.

Thank you, operator. We are encouraged with PC Connection's strong performance this quarter and for the year ending December 31, 2014. We had solid execution across all three of our sales 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.

We were able to accomplish that goal in 2014 with an 11% sales increase and a 20% increase in net income. In a rapidly changing industry, we believe our team and the strategies we have in place will position PC Connection to gain market share and increase long-term shareholder value.

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 your interest in PC Connection are appreciated. Have a great evening.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.