PC Connection Inc (CNXN) 2016 Q4 法說會逐字稿

Good afternoon ladies and gentlemen, welcome to the fourth quarter 2016 Connection earnings conference call. My name is Chelsea, and I will be the coordinator for today. At this time, all participants are in 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 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 Bill Schultz, interim Chief Financial Officer and Corporate Controller. Any statement 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 31st, 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 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.

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 Connections 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.

Thanks Chelsea. Good afternoon everyone, and thank you for joining us today to review the Company's fourth quarter financial results. Q4 was an exciting time for the Company. We pushed GlobalServe, largely completed the integration of Softmart, and we continued our transformation as a global solutions provider. The Company achieved record net sales and gross profit in Q4, and on an adjusted basis earnings per share. Consistent with the overall trending in our industry, demand continued to be muted in Q4, with the exception of some targeted strength in the public sector.

In addition, we saw a reduction in large deals in the quarter, and more aggressive pricing on the deals that did ship. We also experienced strong bookings in our federal business, and we have a large backlog of projects that will ship in Q1. As we review our results, please note that unless otherwise stated, all of our fourth quarter 2016 comparisons are being made against fourth quarter 2015. We also have a full quarter of Softmart results in Q4 of 2016, based on the acquisition date of May 27th.

In Q4, consolidated net sales increased year-over-year by $51.2 million, or 7.5% to $735.5 million. Gross profit dollars in the quarter increased by 6.8% to $98.1 million. Consolidated gross margin decreased slightly to 13.3%, from 13.4% in Q4 2015, due to the increased federal sales, which generally have lower margins. SG&A excluding special charges increased this quarter to $74.2 million, from $68.7 million. This increase was due to higher variable compensation from increased gross profit, three months of Softmart SG&A expense, and our investments over the last year in both sales and technical areas.

We continue to manage costs in this mixed spending environment, and look for ways for the business to be more efficient. This will enable us to continue to invest in the mission critical growth areas of the business. Diluted earnings per share decreased from $0.51 to $0.49. However, adjusted earnings per share which excludes special charges for restructuring, acquisition, and related amortization increased from $0.52 to $0.53 per share. For the full year 2016, consolidated net sales grew by 4.6% to approximately $2.7 billion, and net income increased by 2.7%, to $48.1 million.

As announced last quarter, the Company acquired GlobalServe on October 11th, 2016. GlobalServe has developed a portal designed to meet its customer's global IT needs, with consistent delivery, reporting, pricing, and logistics. We are excited to be able to offer our customers this global capability. This industry-leading tool simplifies our customer's global IT procurement, and reduces their costs. And now with the latest release of the software, OneSource, we can offer this global capability to our SMB customers.

We believe that this acquisition gives us a true competitive advantage in the marketplace, and we expect that this will be an important component of our overall future growth strategy. The integration of Softmart is largely concluded. Softmart's Microsoft business combined with the existing Connection business, makes us one of the top Microsoft partners in the world. We're optimistic that in 2017 we'll see increased sales from Softmart's existing customers, as we go deeper and wider with those accounts. And now I'll turn the call over to Bill Schultz, to discuss the results of our business segments and financial highlights. Bill.

Thanks Tim. Sales for our SMB segment, which serves small to medium sized businesses increased by 5% to $276 million. Strong sales in both mobility and software drove the top line growth. SMB gross margin in the quarter decreased by 20 basis points to 15.7%, due in part to the increased sales of lower margin mobility products mentioned above. For the full year, gross margin increased by 30 basis points to 15.8%, which we attribute to our growth in sales of advanced technology solutions. Sales by our large account segment increased by 4% to $289 million.

Our large account business had to compare against a very strong Q4 2015, which saw 23% growth. Gross profit dollars increased by almost 9%, due to our focus on driving margin improvements. Gross margin in Q4 was 12.2%, a significant increase from 11.7% last year. For the full year, gross margin grew by 84 basis points, to 12.8%. Sales in the public sector segment which includes sales to government and education, increased 18% to $170 million. Sales to state and local governments and education customers decreased by 4%, whereas sales to the federal government increased by 46%. Gross profit dollars for the public sector were up 10% over last year.

Our Healthcare vertical which includes customers in all three business segments increased revenues by 23%, and grew gross profit by 16%. We continued to invest in this vertical which connects Healthcare customers with customized solutions, and is projected to be a growth area for the foreseeable future. In Q4, we incurred $1.5 million of acquisition and restructuring costs. This charge includes costs associated with the acquisition of GlobalServe, and severance related to internal restructuring. In addition, we incurred $470,000 of amortization of acquired intangible assets from the Softmart and GlobalServe purchases. Overall, our financial performance was solid. Earnings per share excluding one-time charges and amortization of acquired intangibles increased to $0.53 per share, up from $0.52 last year. In addition, trailing 12-month adjusted EBITDA increased by 7%, to $95.5 million.

Our balance sheet is healthy. Our year end cash balance of $49 million is lower than Q3's balance of $67 million, due to the $11 million we paid for GlobalServe, as well as higher seasonal working capital requirements. On a year-to-date basis, we generated positive cash flow of $23 million, which is prior to the $43 million spent in acquisitions, and a special dividend of $10.6 million paid in January last year. In Q4, we declared a special dividend of $0.34 which was paid recently. This returned $9 million to shareholders. It is the sixth year in a row that we have declared a special dividend, which now totaled more than $60 million. Our goal 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 approximately $18 million in previously authorized share repurchases. I will now turn the call back over to Tim to discuss current market trends.

Thanks Bill. Our fort quarter and full year results reinforce the importance of product mix and advanced technologies on gross profit margin. We believe our plan is on track. And that our strategy is working. Despite the softness in overall IT spending, we were able to increase gross profits, and thereby grow our adjusted earnings per share.

Looking ahead, current industry growth projections for 2017 are mixed, but in the low single digit range. Our goal is to grow faster than the market by taking share. Note that in Q1 we're projecting strong revenue performance from our public sector business, due to some significant orders in our backlog. We are also focused on advanced technologies, and we're investing in complex areas of the business, in order to help our customers achieve their business outcomes. Our software business continues to grow, including cloud, virtualization, security, and security assessments.

In addition, our new network operating center in Schaumburg, Illinois is now fully operational. We have made investments in our Hybrid IT capabilities and we are also seeing increase in data center assessments. Demand has been strong for converts infrastructure products, and we are experiencing strong growth in our services business. We also continue to target vertical markets, such as healthcare, retail, financial services, and manufacturing.

We believe our business model is more relevant than ever, as we help customers navigate through technology that's more complex and more disruptive. Our acquisition of Softmart and GlobalServe have expanded our capabilities, and increased our customer count, as well as our sales head count. And enhanced our automated sales tools. Our balance portfolio of customer 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 Instructions). Our first question comes from the line of Adam Tindle with Raymond James. Your line is now open.

Okay. Thank you. Good evening. Tim, I just want to start by asking about the cadence of the quarter overall. Did you see any increase in spending post-election? And then looking into 2017 you mentioned that low single digit growth number. I think we are hearing that others are more optimistic for accelerated IT spending into 2017. But your growth target wouldn't suggest that that's occurring. So maybe talk about that dynamic in 2017, and your view on customer budgets?

Sure. For Q4 it really was an interesting time, Adam, it was across the industry I think it was a fairly muted IT spend, as I think you noted. And that is consistent with really what we saw here. We didn't see the large number of large projects. And we did see customers continue to evaluate their data center alternatives, and going forward into 2017, there is a bit more optimism in the air. Clearly there are a couple of drivers. We're seeing more reports that would indicate that software is going to be a significant growth driver for us. We think mobility will continue to be strong. And we also think the investments that we're making in the Hybrid IT space are going to pay good dividends for us. But that said, if you look at IDC and others, they're still in the low single digit range. We are more optimistic than that, in particular because we've done some acquisitions, and so we do expect to outperform the industry norms. But we want to be very conservative. I would say there is some cautious optimism starting to come into 2017, but we have got a long way to go.

Okay. And I don't know if Bill has this, but you guys mentioned in the past that you were expecting about $100 million from Softmart in the second half of the year. I think you implied about $60 million in Q4 for Softmart. Was that the Softmart number in Q4, $60 million?

So Adam, in Q4, both our SMB and our large account teams spent considerable time integrating and training the Softmart account managers. Basically which that integration I'm happy to share concluded as of January 31st, and so the last time Softmart operated independently was really Q3. And accordingly we're not separating the results for Softmart in Q4.

Okay. Well, if I may make some assumptions on my own on what Softmart might have been. I think either way your SMB revenue would have been down pretty meaningfully year-over-year in Q4, on an organic basis. So just wanted to understand maybe what happened in the quarter, was there perhaps some share loss, or is this reflective of market trends? And I think others are attacking, other competitors are attacking SMB market with more digital strategies, and kind of shifting resources. Would be interested to get your take on Connections SMB strategy and how that might change?

So we're certainly not down in a meaningful way. You are probably overestimating the effect of Softmart on SMB. That said, we're making a number of changes to our strategy, but we're pretty bullish overall on the sales center and the model. The team has done a really good job with margins. They've done a great job selling across the solutions stack. And bringing in advanced technologies. And we've done a reasonable job adding customers. So I would say that the overall IT spend was a little lighter than we had hoped, but certainly not a significant decline. And we're pretty optimistic going forward for SMB, or Connection commercial business, for 2017.

Okay. And maybe one last one on margins. You guys had a nice increase in gross margin in 2016. I know Softmart probably contributed some to that, but also some advanced technologies. But the operating margin line was largely flattish, so just wanted to hear you talk a little bit more about this dynamic, and where your view on where operating margins can go into 2017?

So thanks, Adam. So you're correct in general. The gross margin was significant improvement for us last year, and more than anything else, even more than the effect of Softmart, it's our selling what we see as, what we call advanced technology solutions. And these solutions are at a higher margin. They are software. They are data centers. There is security. So on the downside to those is to be able to be that resource to your customers, you have to be able to provide a level of skill and knowledge, and that requires investments into our, what we call our technical services group. So those investments we will continue to make those the next year, and they will result in a higher SG&A in dollars, but not as a percentage of sales for next year. I hope that helps you.

Okay. Yes. Thank you.

Thank you.

I want to comment, we did see some large projects in Q4 the public sector, and those large projects, federal projects, do tend to pull on the margin a little bit. We also saw as I mentioned a slow down in big deals in Q4 for enterprise, and that of course, has the opposite effect if you're not doing those large deals, you don't have that tug on margin. Enterprise team did a terrific job raising margins, and selling those advanced technology solutions.

For the full year SMB margin I thought you heard probably in the call that SMB margin was up 30 basis points for full year. That's the only down side we really had to margin was in the federal area, where we had some large deals, but they were at a lower margin, those large federal deals. But overall, we're very pleased with our margin growth, particularly in the SMB and the large account area.

Thank you. And our next question comes from the line of Anthony Lebiedzinski with Sidoti. Your line is now open.

Yes. Good afternoon. Thank you for taking the questions. I think Tim you mentioned that you expect to see some benefits from your new Schaumburg Illinois facility. I was wondering if you could perhaps expand on that, and give us some additional insight as to what you're thinking about how that will help 2017 and beyond?

Thanks. So in Schaumburg, we're kind of running three different businesses there, if you will. We have a SMB business, which is Teleweb, a call center business. That's new for us in the area, and we're seeing nice growth there. And able to attract talent. So we're pretty pleased with that. We also have our legacy ValCom, or managed services business there, and that's going to be a very strong business, double-digit services growth in the quarter, and that's mission critical to our overall strategy, as managed services enable so much of our growth. And finally, as you mentioned, we did open a network operating center, a NOC, and we're seeing a nice growth there, a nice trajectory upward of customers who want our help managing and securing their networks. That is our Schaumburg business.

Got it. Okay. And I assume that the GlobalServe acquisition really wasn't meaningful as far as contribution to your results for the fourth quarter, that's more of a 2017 benefit, is that fair to say?

That's absolutely right. We are excited about it, though. We're seeing really good funnel growth. We're seeing large enterprise customers who want global capabilities engage us in new and meaningful ways. So that is exciting, so the funnel is starting to fill up there. As I mentioned the OneSource software has been ported now, so that SMB customers can take advantage of it, and that's a great promise for the future.

Got it. Okay. And then lastly, given that you did two acquisitions in 2016, what is your appetite for addition acquisitions in 2017? Or would it be fair to say that you would likely take a step back, and perhaps be looking at more acquisitions in 2018?

Well, it's interesting, first off we really want to assure that we have digested the acquisitions, and that all systems are go. So that's priority one as we go into 2017, just to make sure that we make both acquisitions a real success. With that said, we think we have a solid strategy. We think we have a good team in place, and we think we have a strong balance sheet. So we do remain open to the idea of a tuck-in acquisition if it could strengthen our solutions capabilities, or if it were accretive. So we remain open on the point, but right now we have got a lot to do early in 2017. You may recall we also rebranded the Company in September of last year, and so there will be some exciting things to do there as well.

Got it. Thank you very much.

Thank you.

Thank you. (Operator Instructions). And our next question comes from the line of William Gibson with Roth Capital Partners. Your line is now open.

Hi. You talked about a backlog in the public sector market, and pushing into the first quarter. Is that weighted heavy towards the federal, as well?

It is, Bill, yes. Thank you.

Okay. And just one thing I noticed is on your acquisition costs, it looks like was there a reversal in Softmart, or was that related to the integration, or just fine tuning the numbers? What was behind that?

Are you talking about the adjustments, Bill?

Yes.

So no, there was not a reversal of expenses, Bill, for Softmart.

All right. Just you showed $34 million roughly in the second and $32 million now. And so was that all just the charges we had been having and integration costs? Or what was the difference?

Are you talking about the actual purchase price, Bill?

Yes.

Let me get back to you on that, okay? I mean I will research that.

Okay. And then you mentioned the four verticals, but seem to be really zeroing in on the growth on healthcare. Can you give us just sort of a rough estimate of how large that is? I know you are not breaking out that number. I don't know if you want to disclose that to other competitors or what's behind that?

Let me speak in general terms, Bill. As I mentioned we had really strong healthcare growth, up 23% and that's exciting. There is a lot of promise there for the future when you look at the trends happening with electronic health records, with virtual consults, and perhaps security is a very promising market. But we're seeing a promise in our other verticals as well. If you look at our financial services vertical, there is a potential there with some deregulation to really drive some IT upgrades. We are excited about that.

We're engaging our financial customers. As you know, really the manufacturing world from end to end is changing, as a result of technology, and the Internet of Things. And then finally, the retail world, as well, so we're engaging on all fronts, and we do expect our pure vertical market growth, to be significantly larger than the overall IT industry growth. We see that as a real growth engine for us. And we don't break that out, but when you combine those four verticals, it is significant.

Okay. Thank you.

So Bill, follow up on the reversal, you are correct, the Softmart acquisition was subject to a working capital adjustment which we settled in Q4, and settled favorably and so it netted down to us to be a $31.9 million purchase.

Okay. Good. Thanks.

Thank you.

Thank you. And I am not showing any further questions at this time. I would now like to turn the call back to Tim McGrath for any closing remarks.

Well thanks. I would like the thank all of our customers, vendors, partners, and shareholders for their continued support. And our dedicated co-workers for their efforts. I would also like to thank all of you listening to the call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.

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