PC Connection Inc (CNXN) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2016 PC Connection, Inc. earnings conference call. My name is Danielle and I will be the coordinator for today. At this moment, 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 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 Factors section of the Company's Annual Report on Form 10-K for the year ended December 31, 2015, 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 any 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.

During this call, GAAP and non-GAAP financial measures will be discussed. A reconciliation between the two is available in today's earnings release and at the Company's website. Today's call is being webcast and will be available on PC Connection's website. The earnings release is also available on the website.

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

Thank you, Danielle. Good afternoon, everyone, and thank you for joining us today to review the Company's second-quarter financial results. We had a strong second-quarter in a modest growth environment. We were able to increase earnings-per-share due to solid sales growth and a significant improvement in gross margin percentage. We also acquired Softmart on May 27, which we'll discuss in more detail in a few minutes.

As we review our results, please note that unless otherwise stated, all of our second-quarter 2016 comparisons are being made against second-quarter 2015. Also, note that Softmart's results for the month of June are included in our Q2 2016 results, based on the date of acquisition.

Consolidated net sales year-over-year increased by $49 million or 7.7% to $676 million. Gross profit dollars in the quarter increased by 13% to $94 million. Consolidated gross margin increased to 13.9%, a substantial increase over the 13.2% in Q2 2015.

SG&A, excluding acquisition costs, restructuring charges, and amortization of acquired intangible assets, increased this quarter to $71.9 million from [$63.1 million]. This increase is due to a higher variable compensation from increased gross profit, one month of Softmart SG&A, and the hiring we have done over the last year in sales and technical areas. Diluted earnings per share increased from $0.44 to $0.47. Adjusted earnings per share, excluding acquisition and restructuring charges, and acquisition-related amortization, increased to $0.49 per share.

I would now like to review the Softmart acquisition in some detail. On May 27, we completed the acquisition, and we are very excited about the opportunities this presents. Softmart was founded 35 years ago, which is approximately the same time that PC Connection was founded. The Company has developed a strong Microsoft niche, and in addition to providing hardware software and services, their Microsoft business, combined with the existing PC Connection business, makes us one of the top Microsoft partners in the world.

Softmart has created a strong Microsoft services practice and has developed software licensing optimization tools and processes. This is how thousands of customers streamline and optimize their software usage and licensing requirements.

We believe that the combination of the tools they have created, plus the optimization programs we have developed, gives us some of the deepest capabilities in the industry for software licensing, deployment and management. Softmart has also attained Tier 1 cloud solution provider status with Microsoft. This gives us more robust cloud and cloud services capability in addition to the abilities to provide cloud offering and services electronically.

This is an important transition, as our customers change the way they procure and utilize cloud services. In addition, we believe that Softmart customers will benefit from our deep relationships with other manufacturers in terms of pricing, logistics, and technical expertise, and end-to-end solutions.

There's a good cultural fit between Softmart and PC Connection. We've already started the process of analyzing and taking advantage of best practices at both companies.

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

Thanks, Tim. In regards to Softmart, we will not be breaking out their results separately, because they have only one month included in our quarterly numbers based on the date of acquisition. Softmart's annual revenues are in the $200 million range.

Sales for our SMB segment, which serves small to medium-sized businesses, increased by 8.3% to $281 million. This includes all of Softmart's June revenues, since most of their customers fall into our SMB definition. Gross margin was very strong, as it increased by 78 basis points to 16.2%, led by solid performance in advanced solution categories such as software and networking.

Sales by our Large Account segment increased by 12% to $260 million. This significant growth was primarily due to strong software revenues in addition to strong healthcare performance. Gross margin in Q2 was 12.4%, consistent with the prior year.

Sales in the Public Sector segment, which includes sales to government and education customers, remained flat at $136 million. Gross margin for the Public Sector segment was strong. It increased 149 basis points to 11.9%. Product mix drove the margin improvement, as gross profit dollars for the Public Sector were up 13.7% over last year.

Our healthcare vertical, which includes customers in all three of our business segments, had a very strong quarter with 19% growth in revenues. We continue to focus on connecting healthcare customers with customized solutions in a specialized vertical, which is projected to be a growth area for IT spending for the foreseeable future.

In Q2, we incurred $841,000 of acquisition and restructuring costs. This charge includes professional fees related to the Softmart deal, severance related to internal restructuring activities, and duplicate costs incurred in our office move from Itasca, Illinois to Schaumburg, Illinois. There could be additional restructuring costs incurred in Q3 as we continue to take a hard look at our expense structure.

In addition, we will break out amortization of acquired intangible assets each quarter. The preliminary values assigned to Softmart's intangible assets will result in a quarterly amortization charge of approximately $300,000. In Q2, the amortization was $83,000 because there was one month of activity.

Overall, our bottom-line performance exceeded the prior year. Earnings-per-share, excluding one-time charges and amortization of acquired intangibles, increased to $0.49 per share, up from $0.44 last year. Trailing 12-month adjusted EBITDA increased to $93.1 million.

Our balance sheet is in good shape. The Q2 2016 cash balance of $47 million is lower than Q1's balance, due to the $34 million we paid for Softmart, plus we had a very strong revenue performance in June, which, in the near-term, reduces our cash balance, due to the increase in working capital.

Our goal with excess cash is to maximize shareholder value while maintaining financial flexibility. We continue to assess M&A opportunities and other capital allocations such as dividends and stock buybacks. As a reminder, we still have $17.8 million in previously authorized share repurchases.

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

Thanks, Joe. Our second-quarter results reinforced the importance of product mix and advanced technologies on our overall gross profit margin. We believe that our plan is on track and that our strategy is working.

Despite the softness in overall IT spending, we were able to produce strong gross margins and, therefore, grow our earnings-per-share. Looking ahead at the rest of the year, current industry growth projections for 2016 are in the 3% range. Our goal is to grow faster than the market by taking share. We are highly focused on the Company's mission -- connecting customers with technology solutions, while continuing to grow the bottom line faster than the topline.

We are also focused on advanced technologies, and we are investing in complex areas in order to help our customers drive their business outcomes through IT investments. For example, our software business continues to grow, including cloud, virtualization and security. We're seeing growth in the converged infrastructure, and we also continue to target vertical markets such as healthcare, which grew [19%] in the second quarter of 2016.

We believe the Softmart acquisition will be accretive for the Company, and will be a critical part of our ongoing strategy to connect customers with technology. Many of our customers are just finding and improving their digital strategy, which is enabled and defined by software. We believe that the combined organization will be a leader in its ability to help customers to find, manage, and deploy software solutions.

From a financial perspective, as we integrate the two businesses, there will be opportunities to increase sales to existing customers and win new business as a result of expanded capabilities. The purchase was funded from cash on-hand, and we still have a strong balance sheet with no debt. Softmart is expected to add approximately $100 million in revenue for the last six months of 2016, and is expected to be modestly profitable, with Q4 being slightly higher than Q3 in sales and in profits.

We believe our business model is more relevant than ever as we help our customers navigate through technology that's more complex and more disruptive. 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'll now entertain your questions. Operator?

(Operator Instructions) Adam Tindle, Raymond James.

The first question -- I understand you're not breaking out Softmart, but you did have strong large account revenue growth, and understand that this is primarily -- Softmart is primarily SMB, so probably not as much of an impact there. Could you give us more color on that large account revenue growth, given that this tends to be an area of strong cloud adoption?

So, Adam, thanks. Yes, we did have terrific performance in the enterprise space. As you know, that really is project outcome-based, solution-based rollouts. And we were very strong in the enterprise. In particular, we had really strong software growth, and that was a big driver of the overall growth. In addition, the enterprise healthcare was really strong.

Okay. And on the product side, servers stood out -- I think that was down double digits year-over-year. Can you give a sense of what's driving this? And do you expect a rebound?

Yes, so, thanks. So you probably have to look at that statement in its entirety of really what we're seeing out there is we're seeing our customers evaluate options; there's a lot of technology on the horizon, as you know, with Broadwell and the conversion to Windows 10. In addition, I think customers are evaluating off-prem solutions.

And finally, we saw extraordinary growth in virtualization. And, as you know, when you start to look at the numbers we were driving in terms of virtualization and security, we think that really had an impact. And most importantly, it's project-driven. And so a lot of that also is spotty, based on the particular project and rollouts we're doing at that time. So, we've got a big focus on advanced technologies, and we're very confident that our server business will be just fine.

Okay. And you talk about help -- obviously the goal here is to grow the bottom line faster than the topline. But we had a quarter here where SG&A slightly outpaced gross profit dollar growth year-over-year. Why is this happening? And should this continue? I know you mentioned additional restructuring costs being a possibility?

Yes. So, the first point is that we are constantly looking at our expense structure. And as we see from many other technology companies, we know there are other areas we need to invest in, in the future. And in order to afford that, you've got to kind of look at your legacy area. So that's certainly something that's an ongoing project for us.

I think the numbers this quarter might be a little skewed because of the Softmart numbers being in there -- they were only in there for a month. But really Softmart has higher gross margin percentage than, I guess, traditional PC Connection. And it also has a higher SG&A as a percent of sales than sort of our traditional P&L. So you've got some element of that flowing through the SG&A for Q2 as well.

Okay. Thank you.

But other than that, you are going to see higher SG&A -- SG&A goes up as a function of gross profit dollars. So as gross profit dollars go up, you are going to have higher variable SG&A. And really, over the last year, we've hired a number of salespeople and technical people really to try to drive future growth.

Right. And with those technical people, are you seeing a difference in the variable costs there that -- affecting the model in some way? Or are you still anticipating gross profit dollars to outgrow SG&A and that's kind of the mantra?

Yes, that would be the -- that would definitely be the game plan there. The long-term goal is that, by adding more technical people, we are going to be more successful at selling more advanced solutions, which carry higher margins. So, over time, you should see a gradual increase in gross margin percentage, and you might also see a slight tickup in SG&A percentage as well.

Understood. Thank you.

Thank you, Adam.

William Gibson, ROTH Capital Partners.

You mentioned studying best practices at both companies, and I know we're early in that stage. But if you run across a thing or two at Softmart that you can incorporate into your business?

Bill, thanks. Yes, absolutely -- that was a big part of the attraction for Softmart. There were a number of things. To begin with, the processes and their capabilities around software, their approach to that, helping customers evaluate, assess what they have, helping them deploy what they have in a way that's impactful and generates real cost savings for the customer, is an example of a best practice that will meld with what we call our MLO and XLO -- our licensing -- Microsoft licensing optimization and software optimization. Those two best practices coming together are really going to be impactful -- for example.

Yes. And healthcare, good growth across all the segments. Where are some of the things that are going on in healthcare? I mean exactly what are you doing there?

Well, thanks. We are pleased with the growth that we're seeing. Right now in Q2, I think market conditions, the meaningful use guidelines really drove a lot of growth for the quarter. Clearly, the large GPOs and the enterprise space did very well in the quarter, but we are also optimistic about the future.

As you know, Bill, we have a focus on vertical markets, and we see the healthcare vertical as being probably the leader in growth. Going forward, there are a number of drivers that will continue -- not the least of which is the round two of the HIPAA audits, which are really going to cause many of our customers to go into kind of full force as they look at their IT component.

So we're excited about that. We're seeing a lot more with Pella Medicine. And as I mentioned, we're doing much better with the GPOs.

Good. And what are some other verticals you are potentially thinking about or breaking out?

Yes. So we are very focused on four vertical markets. And the caveat -- my Public Sector group would want me to mention this right away -- we think about Public Sector -- we think of that as a vertical, but any way you slice it, education is a very important vertical. So that's ongoing, of course. And healthcare is ongoing.

But we're also really looking at the retail space, the Internet of Things driving so many changes there; looking at the manufacturing space with all the changes that artificial intelligence, robotics, IoT, and eventually 3-D printing are driving there.

And the financial space is really ripe for an upgrade. There are many legacy systems out there that are standalone. And, of course, security -- a big driver in financial. So those really are the four verticals in addition to the Public Sector as a vertical, and education there.

Okay, good. Thank you.

Thank you.

Anthony Lebiedzinsk, Sidoti & Company.

Thank you for taking the questions. So actually just a follow-up on the last question. Can you give us a sense of how big these markets are as far as education, retail, manufacturing, financial? Just want to understand what's the opportunity that you may have in each of these verticals.

Yes. So we look at the entire US market as being around $200 billion -- you know, some people have it a little higher or lower, but around $200 billion. So between those four verticals, you are probably talking about half of that number. And then you get another big chunk from education and government, and then a series of other industries spreading around the rest. So it's a big opportunity for us.

Got you. Okay. And then, Joe, you also mentioned that you had a strong revenue performance in June. Was that mostly because of Softmart? Or was there other things going on, if you could -- and if so, if you could just expand on that, that would be great.

Yes. You know, June is the quarter-end for a lot of our customers and a lot of our suppliers as well. And so there's sort of a natural rush to the finish line to get in as many deals as you can by the end of June. So, it kind of happens that way every June. Some of our major suppliers like Microsoft, for example, June 30 is their fiscal year-end, so there's a big focus on closing software deals. So, yes, it kind of happens that way many years.

Got you. Got you. Okay. And then, lastly, one of the other questions was about gross margin and SG&A. So, as we saw in this quarter, your gross margin was up but your SG&A as a percent of sales were up. At what point would you say that you will be able to see your operating margins grow meaningfully as you start to leverage those SG&A?

Yes. And that's a great question. Really our goal is to try to grow the operating margins every year at some meaningful number -- let's say 10 to 20 basis points a year. We believe if we grow the topline at an above-market rate, we improve our gross margins as a percent of sales. And we try to hold the line as best we can.

As SG&A as a percent of sales, you're going to get some operating income improvement as a percent of sales every year. So we're not targeting 50 basis points of operating income improvement on an annual basis, but we think something like 10 to 20 basis points is absolutely achievable. So that's sort of what we're targeting right now.

Okay. That's fair. All right. Thanks very much.

Thank you, Anthony.

Thank you. This concludes today's Q&A session. I would now like to turn the call back over to Mr. McGrath for closing remarks.

I'd like to thank all of our customers, vendor-partners, and shareholders, for their continued support, and our dedicated co-workers for their efforts. I'd 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 participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.