PC Connection Inc (CNXN) 2013 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the third quarter 2013 PC Connection, Inc., earnings conference call. My name is Mary and I'll 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 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 facts 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 and 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, 2012, which is on file with the Securities and Exchange Commission, as well as 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 as of any subsequent dates. 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 the 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.

Thank you, Mary. Good afternoon, everyone, and thank you for joining us today to review the Company's third quarter financial results.

I'm pleased with the third quarter performance. Net sales grew at 3.4% despite another difficult quarter for our federal business. We improved gross margins by 23 basis points over the prior year quarter, which helped us to grow earnings per share by 8% to $0.40 per share.

Operating income increased to 3% of net sales for the quarter. And we also increased our cash balance to $77 million. We continue to execute our core growth strategies to deliver a broad spectrum of IT solutions, increase our market share, invest in our cloud capabilities, enhance operational efficiencies, and maximize growth opportunities, particularly in high margin advanced solutions.

We are transforming our business and investing in key areas to help our customers solve increasingly complex IT problems. In addition, our vendor partners continue to look to us as a key resource to reach customers who are seeking the latest products and services. And to assist those customers in solving complex technology problems.

As we review our results, please note that unless otherwise stated, all of our third quarter 2013 comparisons are being made against third quarter 2012.

Consolidated net sales for the third quarter increased year over year by $19.1 million, or 3.4%, to $580 million compared to the prior year quarter. Gross profit dollars in the quarter increased by 6% and our consolidated gross margin increased to 13.2% from 12.9% in the prior year quarter, which is a result of our strategy to focus on delivering higher margin advanced technology solutions to our customers.

We continue to invest in and focus on improving our operations and expanding our solutions sales capabilities. Our standards of excellence include data center, software, mobility, storage, net/com, and life cycle services.

These investments have led to an increase in SG&A. Our SG&A dollars increased by $3.1 million compared to the prior year quarter. Variable SG&A generated part of the increase due to higher sales and gross profit.

Looking ahead, our SG&A will increase by approximately $500,000 per quarter, starting in Q4 2013 as we begin to depreciate the Customer Master Data Management project that was recently put into service. As our business continues to evolve to meet increasingly complex IT needs, our SG&A may increase to fuel future growth opportunities.

Net income for the quarter increased by 7% to $10.6 million and diluted earnings per share increased from $0.37 in 2012 to $0.40 in 2013. We increased our earnings faster than the rate of sales growth by focusing on maximizing our margins and controlling fixed costs.

And now I'll turn the conference 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 size businesses, increased by 7.3% in the quarter to $235 million, with double digit percentage increases in the notebook/tablet, desktop/server, and software categories.

Gross profit dollars for SMB increased by 8% in the quarter, and gross margin increased by 15 basis points to 15.6%. This segment continues to deliver strong margins as demand for our value-added services from small and medium business customers continues to increase.

Sales by our Large Account segment increased by 0.2% this quarter to $193 million. Total gross profit dollars grew 5% for Large Accounts, and gross margin increased from 11.5% in the third quarter of 2012 to 12.1% in the third quarter of 2013, partly due to an increase in storage sales.

Our overall Commercial sales, which is the combination of our SMB and Large Account segments, grew by 4% over the prior year quarter.

Quarterly sales in the Public Sector segment, which includes sales to government and education customers, increased by approximately 2%. Sales to the federal government decreased by $10 million, or 18% from the prior year quarter. Whereas sales to state and local governments and education customers increased by $12 million, or 13% year over year.

Note that we continue to experience headwinds due to constrained federal spending, as this is the third quarter in a row with double digit percentage decreases in our federal business. On a year-to-date basis, federal government sales represent 6% of our consolidated revenue.

Gross profit dollars for the Public Sector increased from the prior year quarter by 2%, and gross margin remained consistent year over year at 10.8%.

Our health care vertical, which is represented in each of our three segments, only increased by 1.2% in sales due to some large projects in 2012 which did not repeat. However, gross margin for our health care sales increased by 38 basis points, which generated a 6% increase in gross profit dollars. We expect health care to continue to be an important vertical for us in future periods.

Overall, our financial performance was solid. In addition to increasing EPS to $0.40 per share, we also increased our trailing 12 month EBITDA to approximately $66 million. And our quarter end cash balance totaled $77 million, up from $64 million at the end of June.

Cash flow continues to be strong, driven by our growth in earnings plus strong working capital metrics. On a year-to-date basis, total positive cash flow equals $37 million. DSOs at December 30th were 37 days and annualized inventory turns were 27 times.

We currently estimate that the December 31st cash balance will be lower than the September 30th balance due to normal working capital fluctuations. We regularly assess how to best deploy our excess cash. Some transactions we have executed in prior years include acquisitions, stock repurchases, and special dividends.

Our goal is to maximize shareholder value while maintaining financial flexibility. So we will continue to review all options available to us.

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

Thanks, Joe. One of our internal goals is to significantly increase sales in advanced technology categories such as networking, software, storage, services, data center, and related areas.

We continue to make progress on this initiative, especially in our net/com, software and server categories. Net/com product sales increased by 8% year over year, accounting for 10% of our consolidated net sales.

Our Public Sector networking sales were particularly strong this quarter, with growth in enterprise networking, security appliances, wireless access, and switches. Software sales increased by 7% year over year, due to higher demand in security, virtualization, office productivity, and operating system software.

Both our SMB and Large Account software teams continued to succeed in maximizing growth opportunities in 2013. SMB grew software sales by 18%, compared to the prior year quarter, with sales in virtualization being notably strong during the quarter.

The overall market is currently undergoing significant changes. Many large technology companies have announced major restructuring plans, which involve reductions in legacy businesses in order to fund investments in cloud computing, mobility, big data, and security.

These changes in market conditions have resulted in adjustments to some of our partners' programs. For example, a large software provider has implemented changes in their channel centers, which could impact our profitability from that product category in 2014. Other suppliers are also assessing changes to their channel programs.

In order to maximize channel incentives and add -- excuse me. In order to maximize channel incentives and our overall productivity and profitability, we need to continue to transform our business and invest in these emerging technologies.

In addition to technology changes and funding pressure that have impacted some of our end user customers, specifically federal government spending continues to be an issue.

Although it's less than 10% of our overall sales, the double digit percentage decreases in sales that we experienced this year have been a drag on our overall growth. It's not clear what the 2014 outlook is in this market space.

Also, enterprise projects for some of our larger customers have been delayed as companies carefully evaluate their alternatives in this complex IT environment.

As we look to the fourth quarter and opportunities that are emerging for 2014, we feel it's critical that we manage our growth appropriately and focus on expanding margins, increases -- excuse me. Investing in solutions capability and keeping our balance sheet strong.

Our goal is to continue to deliver sustained and consistent performance as we move into our 32nd year of operations. We'll now entertain your questions. Operator?

Certainly. (Operator Instructions) Jared Schramm, ROTH Capital.

Looking at the Public Sector, so it's still a decent quarter in light of what you're seeing with the federal government there. Could you just segregate a little bit what you're seeing at the state, local, education side? What's driving the growth there?

And then part two of this question would be, am I little too optimistic to think that there's some pent up demand at the federal level that'll eventually show its face here sometime in 2014?

That's a good question. So to begin with, to kind of put it in perspective, we actually did have a really good quarter in SLED for Q3. In fact, our SLED business was about 71% of our total Public Sector in the quarter. And our fed business was 29%.

And as Joe mentioned, the federal business was down for us. And it's interesting that we are seeing good growth in SLED but clearly have that downward pull from the fed.

Now, looking forward to 2014, we just don't have really good visibility. We don't know when the budget issues are going to be resolved. We understand there could be some pent up demand but I also think these budget issues are fairly significant and wide-sweeping. So we're just very cautious on the year when it comes to the Public Sector.

Okay. And then looking to Large Account, the 60 basis point jump in gross margin in the quarter, could you provide a little more color on what drove that?

Yes. Really it was continued focus on sort of the higher margin technologies. The more advanced solutions. The Large Account space, sometimes you can get some major projects that are at sharp margins.

And this year we actually didn't see a lot of those kinds of projects. We saw a lot more of smaller deals. But those smaller deals generally come at better margins.

So we're continuing to push deeper into software and storage and sort of those higher margin categories. So that was really what kind of carried the day there.

And then turning to health care, you mentioned that there were some large projects in the year ago period which made it difficult to comp in this quarter.

Are we going to return to that kind of mid-teen, low-20s year over year growth in Q4 there? Were there some larger projects in Q4 which will drag into this quarter as far as the comp's concerned?

Yes. So, Jared, I think there are really two parts to the question. First is, we did have some very large project roll-outs that did not repeat. But they were -- they are multi-quarter. So they're very large and they spanned two, actually three quarters in some cases.

So that is behind us. However, looking forward, we think that with our pillar of strategy we are getting some traction. But in the health care space I think we probably under-estimated two significant drivers.

One is -- and both of them not a matter of fact. A matter of law, the legislative changes that have happened.

The first is the ICD-10 change which I'm sure you've read a lot about that really is very significant because all health care providers have to get their billing and their coding in order. And they have a year to do that or they frankly can't bill or collect revenue.

And so when we talk to CIOs in the health care community, they kind of liken this change to Y2K in that it's sweeping and it's all-encompassing.

Now, with all of these changes, there are technology components that could be very helpful. But for right now I think the entire industry is hunkered down trying to get through ICD-10. And the Meaningful Use 2 component from the high-tech legislation.

And so both of those are very significant. However, we do see opportunities to think about what's happening in the business. Clearly, mobility is a really important factor for our customer base. Point of care, compliance, infrastructure, all of these with several million more customers coming into the health care system, storage is really an opportunity.

So we're optimistic but the legislative and the changes are so significant we kind of agree with what IDC and the other analysts are saying that the health care growth is probably going to be low single digits for the foreseeable future or the next few quarters.

Okay. That's helpful on that end. And vendor specific, you seen any shift recently since Dell's going private has got more legs behind it and now they're actually enacting steps to take that forward?

We're seeing some project changes but really nothing significant. Nothing we could point to.

Okay. And then lastly, as your cash balance gets up there, $77 million, I know the last couple quarters when we've spoken you mentioned that a lot of the cloud companies, the multiples that they're asking from an acquisition standpoint are a little lofty.

In the acquisition space on the services side, is anything you're getting closer to as far as completing acquisition? Are you thinking valuations are still a little too aggressive as far as what they're requesting?

Well, yes, Jared, we always -- we remain open to the idea. But we're pretty confident in the business plan that we have. We think we're well poised in the market to continue to grow and to continue to take share.

And we think we've got a really strong team here behind us. With that said, we're always looking for opportunities in a consolidating space, should they be accretive. And should they be a tuck in that would enhance our solutions capability.

Certainly we'd be open to that. And so I think we're open in all areas.

Great. Well, hey, congratulations on the quarter. And thanks for taking my questions.

Thanks, Jared.

Thanks, Jared.

Thank you. (Operator Instructions) Prab Gowrisankaran, Canaccord.

Couple of quick questions. On the federal side, do you see any catch up from the shutdown showing up in Q4? Or do you see it sliding further in Q4? Then I have a follow up.

Hi, Prab, this is Tim. Thanks for joining us today. It's really tricky in that there are a number of drivers out there. And consistent with what our major suppliers would say and had said on their calls.

Things like Windows XP expiring and some of the other changes that are happening in the e-commerce space and the security space. We're optimistic that mobility and security and big data are, in fact, going to stimulate some demand. However, we don't see an end in sight to the budgetary issues.

So we don't want to misrepresent that we think there'd be anything new coming. Because we've seen nothing to indicate that the last three quarters of performance that we've seen are going to change in Q4.

Okay. And the other question I had was in terms of the IT spending, looks like people are expecting a better year in 2014, 3%, 4% growth. What do you see and what do you see as drivers for 2014?

Yes, Prab. So, again, I think there are some drivers. We think some of the functional areas we've invested in here ourselves, we think big data is important. And as customers. And our customers want to know as much as they can about their customers. And so big data is clearly been a driver.

Mobility is a driver. Security is an absolute driver in the space. And overall, we think that there are some points of light out there. And we kind of accept sort of the market rate of growth, if you will.

But everything that we're seeing, the IT spend is going to be at or a little above the GDP rate of growth.

Okay. Great. And the last question on the operating margins I see it's expanded. Do you think you can in 2014 expand beyond -- get to the 3% level for the year?

Yes, I'm not sure about for the full year. But we were happy to get to 3% for this quarter. That was a good starting point for us. Really our near term goal is to get to 3% operating income for a full year.

So that would be our challenge for next year. But I'm not sure I would model that just yet. But we need to continue to grow the top line. We need to continue to increase gross margins. And we need to hold the line on costs. And then that will all fall into place.

But it certainly is our goal to get to 3% operating income and beyond over the next few years.

Great. Thanks a lot for taking my questions.

Sure.

Thank you.

Thank you. (Operator Instructions) I show no further questions at this time and would like to turn the conference back to Mr. Tim McGrath for closing remarks.

Thank you, Mary. I'm pleased with our results this quarter. We increased revenues, gross margin, operating margin and earnings per share while improving our overall working capital metrics in a challenging environment.

We continue to transform our business to provide higher value technology solutions to help our customers solve their business challenges. We believe the strategies that we have put in place will position us well to gain market share and enhance long term shareholder value.

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 who are 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 does conclude the program and you may all disconnect at this time.