PC Connection Inc (CNXN) 2014 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the first-quarter 2014 PC Connection, Inc. earnings conference call. My name is Andrew 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 re-broadcasted 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, 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 represents 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 -- that's 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 first-quarter financial results. We are pleased with our strong first-quarter performance. Net sales grew by 10.8%, led by sales growth of 26% in our Public Sector business. There was significant refresh activity in the quarter due to the Windows XP expiration. We also generated strong sales in Chromebooks, software and networking. The change in product mix as a result of the Windows XP expiration resulted in a lower gross margin, but we were still able to grow earnings faster than sales, as net income and earnings per share both increased by 17%.

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 cloud capabilities, enhance operational efficiencies, and maximize growth opportunities, particularly in targeted vertical markets and higher margin solutions. As we review our results, please note that unless otherwise stated, all of our first-quarter 2014 comparisons are being made against our first-quarter 2013.

Consolidated net sales increased year-over-year by $54 million or 10.8% to $560 million. Gross profit dollars in the quarter increased by 9% to $73 million. Consolidated gross margin decreased 21 basis points to 13% as a result of the product mix shift to lower margin products, such as notebooks and desktops. We continued to invest in and focus on improving our operations and expanding our solution sale capabilities in the following key areas -- data center, software, mobility, storage, netcom, security, cloud, and lifecycle services.

These investments have led to an increase in SG&A expense. Our SG&A dollars increased by $4.4 million. However, SG&A as a percentage of net sales was favorable by 31 basis points. Variable SG&A accounted for part of the increase in dollars due to higher net sales. In addition, SG&A in the first quarter of 2014 included approximately $500,000 of depreciation related to our customer master data management project. Fixed SG&A will increase in 2014 due to planned additions to our sales teams, a full year of depreciation on the MDM project, and additions to our technical resources, including engineers focused on data center and cloud solutions.

Net income for the quarter increased by 17% to $7.1 million, and diluted earnings per share increased from $0.23 to $0.27. We increased our earnings faster than the rate of sales growth by leveraging our fixed cost over higher net sales.

And now we'll 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-size businesses, increased by 7.5% to $253 million, with double-digit percentage increases in the notebook, desktop and software categories in this segment. Gross profit dollars for SMB increased by 6%. However, gross margin decreased by 19 basis points to 14.9%. The decrease in gross margin was due to increased demand for lower margin products, such as notebooks and desktops.

Sales by our Large Account segment increased by 7.8% to $201 million. We experienced double-digit percentage sales growth in both notebooks and desktops. Total gross profit dollars grew by 12% and gross margin increased from 11.5% to 12%. Our overall commercial sales, which is the combination of our SMB and Large Account segments, grew by 7.7% over the prior-year quarter. Quarterly sales in the Public Sector segment, which includes sales to government and education customers, increased by 26%. Sales to state and local governments and education customers increased by 29%; whereas sales to the federal government were up 20%. Federal government sales represented 5% of our consolidated revenue in Q1.

Gross profit dollars for the Public Sector segment increased by 11%, and gross margins decreased from 11.9% to 10.5%. The decrease in margin is attributable to the significant increase in sales of lower margin notebooks and Chromebooks during the quarter.

Our healthcare vertical, which is represented in each of our three segments, increased in sales by 4%. We expect healthcare to continue to be an important vertical for us in future periods. However, there is continued uncertainty in the market due to ongoing changes in government regulations. Program reimbursements for healthcare could be impacted, which may result in delays in IT investments.

Overall, our financial performance was solid. In addition to increasing EPS to $0.27 per share, we also increased our trailing 12-month adjusted EBITDA to $69.5 million. During the first quarter, we generated $22 million of positive cash flow. The Q1 2014 cash balance of $64.9 million is higher than our 2013 year-end cash balance, due to seasonally lower working capital requirements. 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. We are pleased with PC Connection's results this quarter. Our long-standing customer relationships put us in position to benefit from the Windows XP expiration, which drove significant refresh activity in categories such as notebooks and desktops. In addition, we increased sales of our more complex areas, especially software and networking, as we've continued our transformation into a national provider of advanced IT solutions, focused on helping our customers solve their business challenges.

The overall IT market continues to undergo significant changes. Some of these market changes have resulted in reductions in certain partner funding programs for 2014, particularly in software. In order to maximize channel incentives and our overall profitability, we need to continue to transform our business and invest in emerging technologies, which will increase our SG&A expenses.

As we look out to the balance of the year, we believe that sales growth will return to levels that are consistent with industry expectations. We experienced substantial growth in Q1 from several areas that are not likely to continue to grow at the same rate for the rest of 2014.

One area was the expiration of Windows XP. There could be additional Windows XP activity for the next couple of quarters, but it's not expected to be at the Q1 levels. Our sled business grew 29% in Q1. We expect to have growth in sled for the balance of the year, but it's unlikely to continue at the Q1 rate of growth, since the year-over-year comparisons will be much more difficult for the rest of 2014. Our federal business was up 20% in Q1, but the sales growth was mainly attributed to several large deals that had relatively low margins.

We expect that for the rest of the year, federal sales growth rates will be in the low-single digit range, which is consistent with industry expectations for the federal space. 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 a lengthening of purchasing decisions in some complex solution categories. Industry experts have projected overall IT growth rates in the 4% range for 2014, which we believe are reasonable.

As changes in the market continue to unfold, we feel it's critical that we manage our growth appropriately, with focus on expanding margins, investing in solution capabilities, and keeping our balance sheet strong. 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 will now entertain your questions. Operator?

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

Looking on the federal government side, obviously, a nice -- see a bounce-back quarter there. Tim, you talked about some moderate growth going forward at the federal level here. Is it safe to say that the difficult period we saw for the previous couple quarters are now behind you?

You know, it's really tough to make that call. So, when you think about that Q1, 27% of our business was in the federal space and 73% in the sled space. And generally, we see pretty good growth in the sled space. Federal base, we did see a good recovery. And we are optimistic but we're just not confident that we can say that the slowdown is behind us. And we are still projecting sort of that mid-single digit growth range.

Looking on the acquisition side, how active do you anticipate being in this market for the remainder of 2014? In particular, anything on the higher margin consulting side being attracted you of recent?

So, we've been looking at potential deals fairly regularly. A lot of deals come across our desk. Really, right now, the valuations have been the biggest problem, that some of these higher-end VARs who are focused on data center or storage, they really are expecting a big multiple for their businesses. So we are absolutely looking at deals all the time. It's really been a question of finding the right one that we can get at the right price.

In addition, Jared, I would add that we are very confident in our business plan and our people. We are, we think, taking share and growing in some key categories. So while we are interested in evaluating opportunities, and we do think the market is going to continue to consolidate, we don't feel that there is a sense of urgency to do that. We're going to be very selective in the process.

Tim, you mentioned that purchasing decisions seem to be lengthening. Any metric you can provide there? Is this a matter of three months going to nine months? Six months going to a year?

Well, probably not -- I do review the finals when we look at that. And, as you know, Jared, just much of the technology is more complex, especially in the data center arena. And there are several new and disruptive technologies coming into play.

And so that just makes the decision harder for our customer base as they really evaluate what's best for them. Sort of the upside of that is that that makes our value proposition a little stronger for them, as we help them through that process. So I don't have any specific data that says a sales cycle has been moved from 90 days to 120 days. But I can tell you, clearly, there's more technology that makes the decision harder for them.

And then, lastly, looking at the Windows XP expiration. Obviously got a nice bump up from that this quarter. You mentioned that you expect this will drag out for the next several months. Is that to date, so far -- I guess two-part question -- April? Was that still a pretty solid benefit you expect this to carry on for the rest of 2014?

So, clearly, there's going to be some carryover, yes, but not at the rates that we saw in Q1. And we saw some really significant growth rates in Q1. And you know, we talked a little about the effect that had on the margin. Think about notebooks, and in particular, Chromebooks in the public sector -- those are slightly lower margin products than the advanced technology suite of products.

So we saw really the growth in Q1. We think that's going to continue, but it's absolutely going to tail off. So, we're going to get right back, we think, fairly quickly to normal growth rates.

Well, thanks for taking my questions. And congrats on the quarter.

Thank you.

Thanks, Jared.

Prab Gowrisankaran, Canaccord.

Thanks for taking my question and congrats on the quarter. A couple quick questions on -- in terms of as you see the Windows XP refresh tail off, I'm assuming you would expect gross margins to pick back up? Or do you expect Chromebook and others to keep it at these levels? If you can provide some color just on what the trend you think will be the rest of the year.

Yes. So I think you're going to see some Windows XP activity for the next couple of quarters. It won't be as significant as Q1, but really there is almost a direct relationship. The more you have in those categories, the lower our overall gross margin is going to be. So as the Windows XP thing flushes out, you're going to see, hopefully, our margins pick back up again. So it's kind of an inverse relationship there.

Okay. And another question I had was if you can talk about the sales in your higher value segments? You talked about software and networking being strong. How about storage in other segments? And if you can provide any color on where you see it going?

So, there's actually a table in our earnings release that breaks out the exact numbers. Software was very strong this quarter with 14% growth. And that's going to be a mixed bag of security and virtualization, and regular office software. So that's been a continuing growth story for us the last several quarters. And we expect that to be strong for the rest of the year. Networking was very good in the quarter with 8% growth.

So those two categories were some of the more complex areas that we did really well in. And storage was actually down 5% year-over-year. And really, that gets back to what Tim was talking about, sort of a lengthening cycle in the decision process. So that's what we found, is that people are taking more time on some of these bigger decisions. And so it hasn't been strong for us, at least this past quarter. But we are highly focused on growing that category.

Okay, great. And one last question, just on the overall growth rate, just based off the strong start, do you expect -- I know you talked about maybe the 4% level; do you see getting over that -- higher than that, just based on this Windows XP refresh?

Well, 4% is rough and tough where the industry experts have estimated the growth for the year. So we think maybe we'll be slightly above that number. But you know, once again, kind of the higher we get above that number, you're probably going to see an offset to some extent in our gross margin percentage. So, that would be the one thing I would caution you on as you are building your model.

Okay, great. Thanks a lot for taking my questions.

Thank you.

Jeff Koche, Raymond James.

It's Jeff in for Brian. Really quick question. I think you -- I mean you said that the Chromebooks were really strong. And it sounds like that's going to be tied to the public. You are not seeing any adoption on the enterprise or other -- or the small or the large businesses, are you?

Nothing significant, Jeff. So, thanks. We are seeing really significant growth in the education space. And that's (multiple speakers) been the sweet spot.

Was that -- is that tied, do you think, to the expiration of XP? (multiple speakers) Or is it --?

No, it's really more tied to sort of the K-12 education space, where a lot of school districts are implementing things like Common Core and -- or a computer for every kid in the school. And that's really where we are seeing a lot of action in terms of Chromebooks.

Okay. And you said that that netcom was strong -- or it obviously was, it was up high-single digits. It sounded like it was stronger more in the public. Can you talk -- give us some color on what drove that?

Yes. I think, Jeff, that higher ed was the driver of that. We had really good growth in our sled space, and there are a number of factors there. We are seeing good adoption all the way around with security, which has really been a hot spot. And overall, software is strong and I think will continue to be strong.

Outside of public, was netcom up?

Yes. Oh yes. We were up in all segments.

And you were kind of talking about -- I know storage was down; I'm not sure if you broke out servers, but I take it that that segment was helped more on the desktop side. And so I'm just kind of curious, there seems to be like a little bit of a disconnect between how you're doing it netcom and storage and servers. Just wondering what you see there?

Yes, I do think that will level out. We had reasonable server performance, and I think very good netcom software performance. And we are going to be recovering and very focused on the storage side. Again, lots of new and -- as you've written about it, or Raymond James has -- lots of new and disruptive storage players in the market, combined with, of course, cloud offerings. And so for that segment of the business, I think there's a lot of moving pieces.

Yes. So are you seeing a lot more demand for flash? And if you could, as a side note, kind of talk about your cloud strategy. I know you guys are investing pretty significantly. And I'm sure it's growing of a very small base, but how are you -- how do you -- what's your strategy to kind of counteract some of the disruption for tiered traditional businesses?

Well, thanks. So, yes, first part of your question, we are seeing growth in flash. And then we are excited about what we are doing with our cloud business. So in our cloud business, we have a strategy that really helps our customers kind of discern what their needs are. And if that need is to go to a public cloud, then we will help them. If that need is for a private or a hybrid cloud, then we will help them or build that out for them. And in addition, we resell several cloud offerings from our mainstream suppliers, like VMware and HP.

I know some of the distributors are kind of trying to become more cloud aggregators. Do you see -- I mean, is that kind of one of the capabilities that you are working on right now, and something that you are differentiating with? And are you looking kind of to maybe go with the distributor offerings? Like Ingram has announced several initiatives and partnering with Parallels. Just wondering what you guys are thinking there?

So, that's a good question, Jeff. We are cautiously optimistic, and we are evaluating that. We work closely with our distribution partners. But before we put our stamp of approval on an offering, we're going to vet that out and make sure that we are getting our customer base involved in a very strong solution. So, obviously, the strong offerings from IBM, HP, Microsoft, VMware, those are easy for us. Those are solid offerings and we are getting great traction there.

With the more of the public offerings, and more of the one-offs, right, we are going to measure twice and cut once. Because there's an awful lot of space, as you know, for a monthly annuity to move a workload off-premise, we've got to ensure that that's the right premise for our customer.

Great. Well, thanks for answering the questions, guys.

Thank you.

Thanks, Jeff.

Thank you. (Operator Instructions). And I am seeing no further questions in the queue at this time. I would like to turn the call back to the speakers for closing remarks.

Well, thank you, operator. 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 interest in PC Connection and your time are appreciated. Have a great evening.

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