PC Connection Inc (CNXN) 2012 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Fourth Quarter 2012 PC Connection, Inc Earnings Conference Call. My name is Shawn, 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 being recorded and is the property of PC Connection and may not be recorded or re-broadcasted without specific permission from the Company.

On the call today is Tim McGrath, President and Chief Financial -- 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 Provision 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, 2011, which is on file with the Securities and Exchange Commission as well as in the other documents this 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 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 already seen the press release, you can contact Janice Rush at 603-683-2322, and she will email a copy to you. You can also view it on the Company's website. Today's call is being webcast and will be available on 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 fourth quarter and annual 2012 financial results.

During the quarter the IT market continued to be challenging due to ongoing tough market conditions. Concerns related to potential tax increases, federal spending cuts, and the overall softness in the economy resulted in customers delaying IT investment spending. 2013 is projected to be a slightly improved growth environment for IT spending, but still in the low single-digit range.

We will continue to execute our core strategies, delivering a broad spectrum of IT solutions, increasing our market share, investing in our cloud computing practice, CloudConnection, enhancing our operational capabilities, and driving productivity gains. Our Companywide focus on these goals resulted in a solid Q4 and annual performance.

As we review our results, please note that unless otherwise stated, all of our fourth quarter 2012 comparisons are being made against our fourth quarter 2011 results.

Net sales for the quarter increased year-over-year by 1% to $556 million. Sales for our public sector and large account customers increased year-over-year by 9% and 3%, respectively. Sales for our small-sized and medium-sized business increased 1% year-over-year; however, weakness in our consumer sales resulted in an overall year-over-year decrease of 5% in the SMB segment.

Our healthcare business remains strong as revenue increased 23% over the prior-year quarter. We are taking market share in this strategically important component of our business.

We continue to invest in and focus on improving our operations and expanding our solution sales capabilities. Our centers of excellence include datacenter, software, mobility, storage, and netcom, and lifecycle services. We expect to continue to invest in these important practice areas, which are part of our branding and strategy for CloudConnection.

Our adjusted EBITDA increased 25% in Q4 versus the prior-year quarter. Net income for the quarter increased by 19% to $8.9 million, and diluted earnings per share increased from $0.28 per share in 2011 to $0.33 per share in 2012. We continue to strive to increase earnings per share at a faster rate than the growth in sales by focusing on improving gross margins and controlling costs.

Gross profit dollars in the quarter increased by $3 million, or 4%, to $71.7 million. Gross margin increased to 12.9% compared to 12.4% in the prior-year quarter. Our strategic focus on solution selling has resulted in ten straight quarters of year-over-year margin growth.

We are managing our costs as we expand our gross margins. Due to tight cost controls, our total SG&A for the quarter remained relatively flat year-over-year in both dollars and as a percentage of net sales.

As you know from our previous calls, we are implementing our Customer Master Data Management, or MDM project. We're confident that this initiative will enhance our capabilities to better serve our customers and provide a platform for additional opportunities to sell more products and services. The project will be implemented in 2013, and we expect depreciation expense for this project to add approximately $2 million in annual SG&A expenses.

On an annual basis, demand was affected by softness in the macroeconomic IT environment and concerns on potential tax increases on the horizon. Sales growth rates for the industry are projected to be in the low single digits in 2013 as these issues continue to impact IT spending.

2012 net sales increased 3% over 2011 to $2.2 billion. Increased sales for our small and medium businesses, large account customers, and government and education customers contributed to the revenue increase. Our large account segment had the highest increase with 2012 sales increasing by 9% over the prior year.

Our public sector sales increased by 3% in 2012 over the prior year with higher sales to both federal and state and education customers contributing to the increase. Sales for our small and medium businesses increased by 3%; however, this increase is offset by a decline in consumer revenues resulting in an overall decrease of 2% in 2012 for the SMB segment.

Annual gross profit dollars increased by 6% to $282 million in 2012 compared to 2011. Each of our segments improved gross margin, and as a result margin increased year-over-year by 50 basis points to 13.1%. We've continued to look for ways to drive growth and expand margins primarily by focusing on higher-end solution sales.

SG&A expenses increased as a percentage of net sales from 10.3 in 2011 to 10.5 in 2012. The increase was due primarily to investments in our service, support, and solutions selling areas, as well as higher variable compensation related to increased sales.

Included in our 2012 results were pre-tax charges of $1.1 million related to retirement and severance benefits. Our adjusted EBITDA, which is adjusted for stock-based compensation and the special charges, increased by 16% in 2012 to $63.3 million. Pro forma net income excluding special charges increased 19% to $33.8 million or $1.27 per share in 2012 compared to $1.07 per share in 2011.

And now I'll discuss the quarter results for our business segments and cover some product trends.

The top product trends in the industry are mobility, cloud, big data, and software. We're focused on delivering solutions that help our customers execute their business strategies in these critical areas with customized IT products and services.

Net sales for the SMB business segment were $228 million in the fourth quarter of 2012. Sales to small and medium businesses increased by 1% year-over-year; however, when combined with the lower consumer sales, the overall segment decreased by 5%.

Gross margins for SMB increased by 60 basis points resulting in a 14.6% margin. Our SMB segment continues to have the highest gross margin of our three business segments.

Sales by our large account segment increased this quarter by 3% to $202 million. Gross profit dollars increased by 6%, and the margin rate increased from 10.8% to 11.2% during the quarter as a result of our strategic focus on improving results through higher margin sales.

Quarterly sales in the public sector, which consist of sales to government and education customers, increased by 9% to $125 million. We gained share in the quarter in a challenging public sector environment. Sales to local government and education customers increased by 7.5% and sales to the federal government increased by 10.7% year-over-year.

Gross margin for the public sector increased by 60 basis points compared to Q4 of last year. The continued increased gross margin in this segment with eight straight quarters of year-over-year margin improvement due to our focus on higher margin solution sales.

In each of our business segments we continue to invest in people, systems, and infrastructure to fuel future sales growth and improve operational efficiencies. We are focused on developing and maximizing service capabilities in our CloudConnection practice area in order to drive growth in this strategically important market.

And now Joe Driscoll will discuss our financial results in more detail. Joe?

Thanks, Tim. In summary, our bottom line results for the quarter were solid, especially considering the continuing macroeconomic concerns.

Earnings per share increased from $0.28 to $0.33 per share in the quarter, an increase of 18%. On a year-to-date basis pro forma EPS increased 19%. This is our third straight year of double-digit earnings growth.

Gross margins were well above the prior-year period, and we generated significant positive cash flow in 2012 from improved profitability and working capital management. Our cash balance was approximately $40 million, and we had zero bank debt outstanding at December 31, 2012.

We had two significant cash transactions in the fourth quarter. The first was a $10.1 million special dividend. This was the second year in a row that the Company has paid a special dividend. We believe this transaction was a significant reward for our shareholders, especially given potential changes in tax laws related to dividends.

The second transaction was the purchase of a total of 600,000 shares of common stock from the two large shareholders for approximately $6.3 million. This transaction will be accretive to future earnings, as it will reduce diluted shares outstanding to approximately 26 million from 26.6 million.

The Company had sufficient cash on hand to execute the dividend and the purchase of treasury shares as evidenced by the year-end cash balance of approximately $40 million. We will continue to look for ways to enhance shareholder value in the future as opportunities present themselves.

Cash flow provided by operations for the year ended December 31, 2012, was $69.7 million compared to cash used of $5.3 million in 2011. The primary driver for the increase was a $26 million decrease in accounts receivable.

Day sales outstanding or DSOs were 41 days as of December 31, 2012, compared to 47 days as of December 31, 2011. In addition, inventory levels decreased by 8 million from December 2011 due to tighter working capital management.

Capital expenditures in 2012 totaled $9.3 million compared to $10.9 million in 2011. These expenditures were primarily related to our Customer Master Data Management project, which we expect to place into servicer in 2013.

According to market research and announcements from other technology companies, 2013 is projected to be a slightly improved growth environment in IT spending. As we look to develop opportunities in the coming year, we feel it is critical that we maintain a strong core and focus on margin improvement, cost controls, and cash flows.

We will now entertain your questions. Operator?

Thank you. (Operator Instructions.) I have a question from Brian Alexander with Raymond James. Please go ahead with your question.

Hi. It's actually Ari on the call for Brian today. So this last quarter and this quarter you mentioned that both state and local education, as well as federal, were strong. Just with what's kind of swirling around about federal budgets, do you kind of think that that momentum can continue? Do you think you can continue to take share even as the budget declines?

Obviously we're watching what's happening with the federal government and certainly that could have a potential affect on us, but we do think that we're well positioned. We've got a number of contract vehicles in place, and we think that in this market place we can continue to take share.

Got it. And now how much, if you'd be able to quantify, how much is healthcare of that, because it's a strong burn segment?

Actually, that's a great question. As I mentioned, it's a really important vertical that's growing for us, but we don't include healthcare in the public sector subsidiary in gov connection. Healthcare is booked over all three subsidiaries. We have an overlay company, HealthConnection, that helps provide support and marketing to all of our divisions to help drive healthcare and serve our customers. So the fastest growing piece of our healthcare is actually in the large accounts space.

Got it. Thank you. If I may have another, just wondering your outlook for IT spending, you're saying low double digits now this year.

Oh, no. Low single digits.

Oh, sorry. Low single digits. Excuse me. Now this year probably see that clock in at less than 2%. So do you think that you guys will still be able to grow faster than the market in 2013?

Yes, I do. So you're right, this year I think our Gartner about 1.7% was where the year ended up for IT spending. And of course you know the GDP announced today now about 2%. And our goal has always been to try to grow at about double the rate of the GDP in IT spending. So we think that the low to mid single digit is about the right range for us to target.

Got it. Thank you. And now just turning to the gross margin. I've noticed that average order size has been ticking up over the past few quarters. Is that kind of what you were talking about, you'd focus on more solutions selling?

Yes. So as we focus on the advanced technologies and really helping the customers solve their business problems with IT solutions, it tends to be a much more comprehensive approach and they are higher margin products, so it's a mix issue. And the storage systems, servers, the software are higher margin for us.

Got it. And then again on that issue, you mentioned servers, and I guess you called that in the press release that those are weak again. And if we look to Gartner data probably saying it's going to be down 1% to 2% on the year. Do you guys feel that that market might be stabilizing a little bit, or what's your general sense from your customers?

You know, really first I have to put it in perspective. We're looking at -- in Q4 we're looking at a year-over-year comp. In Q4 we had a pretty tough comparable. We had some very large server rollouts in Q4 '11 as compared to '12. So that of course is a driver.

And then we look at the growth that we're seeing in cloud and virtualization and some of the other trend data, and of course that's a driver. But we did exit Q4 with strong backlogs. We are seeing some points of light with our customer projects, and we do anticipate that our datacenter practice area combined with some of the market trends will start to bring the server line back certainly.

Also note that we combine desktops and servers in the category and that we had terrific growth with the notebook category. Desktops and servers were a little below that, but desktops also weighed on that category.

I see. Well I guess I'll stop there for now and if there's anyone else in the queue, I guess I'll turn it over to them for now.

Feel free to come back in queue.

Thank you.

(Operator Instructions.) I have another question from Brian Alexander. Please go ahead with your question.

Hi. Thanks again, guys. It's Ari again. Just wondering if you could speak a little bit more about your CloudConnection platform and how are you really using that to kind of address some of the trends that you mentioned, mobility, big data, especially big data I guess?

Thanks, Ari. What we're doing is we have six major practice areas that we call ProConnection, and they are datacenter, lifecycle, storage, Netcom, and software. And so -- I think that was all six. And so what we find is that overlaying solution architects and experts over the top of all of the practice areas who can also help with specific cloud issues really has been very beneficial.

So that's a program that we started last quarter and we're rolling out in full force this quarter. But for example, if you're engaging a customer and helping them with their IT needs, you might be having a datacenter conversation which quickly turns into a virtualization and software or security conversation which may turn into storage or power and cooling. So we find that we need solution architects who can speak to all of those areas in a very technical and competent way to help our customers navigate through.

So we will help our customers enable their clouds, whether that's a private cloud or a hybrid strategy, and through CloudConnection we're aggregating cloud services and software as a service together to offer very select partners to our customers based on their specific needs.

I see. Thank you. Another question I guess which kind of has come up in some of the distributors who I imagine you are their customer, they've had issues implementing these new ERP systems, and I was wondering would you say that you're MDM system is something kind of like that? And tech data, for example, has had trouble executing in the US because of the difficulty in implementing that system and getting the sales force ramped up on that? So if you could just kind of maybe talk to how -- is this MDM system kind of similar to what they implemented?

Yes. Thanks, Ari. That's a great question. MDM stands for Master Data Management, and really what we're doing is we're consolidating all of our databases together. So as you know, we have some subsidiaries we have in e-commerce business, they have a customer database and operating database. By bringing all the data together it really becomes a foundation, and it is absolutely the database layer. It is not, as you compare it to distributors, and ERP rollout.

So better data gives us better marketing capabilities, gives us a much better approach to our customers using analytics to be more proactive to their needs and start to predict some of those needs. But it is not an ERP solution. It is very much a database layer and a foundational solution.

I see.

So we don't see there is any risk to interrupting any business with our customers because it really is not that type of a system upgrade.

So it's not like a CRM or anything like that?

No. So we have CRM systems and you could layer a CRM on top of it, but ERP is -- excuse me, MDM is strictly Master Data Management and a database upgrade, not CRM and not ERP.

I see. Okay. And I guess maybe the biggest question is like you said ten straight quarters of gross margin expansion. What do you see as kind of the long-term goal for that? Where do you see -- maybe if you kind of have a target goal or maybe like a plateau level that you'd like to reach?

Sure. I'll kind of lead it off and then I'll have Joe just kind of follow it up. As you look at our business plans, we're very focused on topline growth and bottom line profitability. And as you know, finding that balance sometimes is tricky. We have found that transitioning into solutions and to providing more solutions to our customers does yield some higher margins, but we're very conscientious of that balance between growth and margin expansion.

And so we've done a nice job expanding margins, but growth is also on the agenda. Joe?

You know, we're not giving any specific guidance. We would love gross margins to keep going up and up. We don't have a specific target in mind, but I'm going to echo what Tim said. There is a balance there. If you grow faster, it's quite possible that the margin percentage would not grow at the same rate. If you take on more larger deals, which might be more competitively bid out, your margin doesn't necessarily go up on deals like that.

So there's a balance there. We are absolutely striving to grow the margin, but I'm not sure we're going to project it or predict it at this time.

Well, okay. Thanks a lot guys. That's it for me. Congrats on the year and the quarter. Great stuff. Thank you.

Thank you.

Thank you, Brian.

I'm not showing any other questions in the queue. I'd like to turn it back over to Tim McGrath for closing comments.

Thank you, operator. So doing the third quarter, we continued to drive gross margin improvement and double-digit earnings growth while facing soft demand due to the macroeconomic environment. Overall 2012 was a strong year for the Company as evidenced by our 19% growth and pro forma earnings per share and the $70 million in cash we generated from operating activities.

Our performance enabled us to pay a special dividend to shareholders for the second year in a row, fund our capital expenditures related to enhancing internal IT systems and purchase common stock in an accretive transaction.

In 2013, we're focused on topline growth and improved bottom line performance to enhance earnings and shareholder value.

Thank you for joining us for our 2012 yearend earnings call. I'd like to extend a special thanks to all of our customers, vendor partners, and shareholders for their continued support, and our dedicated co-workers for their efforts. Your time and interest in PC Connection are appreciated. Have a good evening.

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