PC Connection Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 2.13 | About: PC Connection, (PCCC)

PC Connection (NASDAQ:PCCC)

Q1 2013 Earnings Call

May 02, 2013 4:30 pm ET

Executives

Timothy J. McGrath - Chief Executive Officer and President

Joseph S. Driscoll - Chief Financial Officer, Senior Vice President and Treasurer

Analysts

Jared Schramm - Roth Capital Partners, LLC, Research Division

Jeffrey Koche

Operator

Good afternoon, ladies and gentlemen, and welcome to the PC Connection, Inc. First Quarter 2013 Earnings Conference Call. My name is Matthew, and I will 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 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 Factor 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 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 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 e-mail 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.

Timothy J. McGrath

Good afternoon, everyone, and thanks -- thank you for joining us today to review the company's first quarter financial results. During the quarter, the IT market showed continued softness in overall spending trends. Despite the challenging environment, we had a solid quarter and we delivered sales growth with positive cash flow. We will continue to execute our core strategies to deliver a broad spectrum of IP solutions, increase our market share, invest in our Cloud Connection, enhance our operational capabilities and drive productivity gains.

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

Net sales for the first quarter increased year-over-year by $7 million or 1.3% to $505 million compared to the prior-year quarter. Our overall commercial business, which is the combination of our SMB and Large Account segments, grew by 3.8%, while our Public Sector sales decreased due to reduced federal government spending.

Our health care vertical continues to be strong with 21% year-over-year growth. We continue to invest in and focus on improving our operations and expanding our solution sale capabilities. Our centers of excellence include data center, software, mobility, storage, Net/Com and lifecycle services.

We expect to continue to invest in these important strategic areas, which are part of our branding and strategy for Cloud Connection.

Adjusted EBITDA for the last 12 months increased by 11% over the prior year to $63.3 million. Net income for the quarter increased by 11% to $6.1 million and diluted earnings per share increased from $0.21 in 2012 to $0.23 in 2013.

As noted in the first quarter 2012 earnings call, pro forma earnings per share in 2012 totaled $0.23, excluding special charges.

We continue to strive to increase earnings at a faster rate than our growth in sales by focusing on maximizing our margins and controlling costs.

Gross profit dollars in the quarter increased while our gross margin decreased by 13 basis points to 13.2%. Both SMB and Large Account margins decreased slightly; however, Public Sector margins remained stable year-over-year despite widespread concerns about government spending.

We are managing our costs as we continue to drive sales growth. Our total SG&A expense for the quarter decreased as a percentage of net sales from 11.3% to 11.2%. We're continuing to invest in our solution sales capabilities and as a result, we expect to add to our SG&A expenses as the year progresses. However, we are highly focused on improving efficiencies and streamlining operations wherever possible. Variable SG&A is also projected to increase for the remainder of 2013 as sales and gross profit seasonally increase from Q1 levels.

And now I'll discuss the quarterly results of our business segments and cover product trends. Sales for our SMB segment, which serves small to medium-sized businesses, increased 5% in the quarter to $236 million. SMB net sales increased by 8%. In addition, we saw a growth in notebooks, desktops and services. Gross profit dollars for SMB increased by 4% in the quarter; however, gross margin decreased by 14 basis points to 15.1%. This segment delivered our highest gross margins as demand for our value-added services in small and medium business customers continues to increase.

Sales by our Large Account segment increased this quarter by 3% to $186 million. Gross profit dollars were relatively unchanged, while gross margin decreased from 11.8% in the first quarter of 2012 to 11.5% in the current quarter due to a slight change in product mix.

Software continued to be a growth category for our large accounts. We've made investments in our software team during 2012, and this team has been very successful in winning new business in the Large Account sector, with strong growth in network, management, security and license renewals.

Quarterly sales in the Public Sector segment, which include sales to government and educational customers, decreased by approximately 10%. Sales to the federal government decreased by $10 million or 29% from the prior year, where our sales to state and local government and education customers showed slight growth year-over-year. The federal government space continues to be challenging in light of the ongoing concern of the impact of the federal budget spending cuts that began early in 2013.

Note that the federal government only represents approximately 5% of the company's total Q1 2013 sales. Gross profit dollars to the Public Sector decreased from prior year by 10% as Public Sector gross margin remains flat compared to the first quarter of last year.

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

Joseph S. Driscoll

Thanks, Tim. In summary, our results for the quarter were solid, especially considering the continuing macroeconomic concerns. Total net sales increased by 1.3% despite a 29% decrease in our federal government sector. We decreased our SG&A rate compared to last year, and we generated significant positive cash flow in the quarter through improved profitability and working capital management.

Our cash balance was approximately $59 million at quarter end, and we had 0 bank debt outstanding.

Cash flow provided by operations for the quarter ended March 31, 2013, was $19 million. The primary source of operating cash during the quarter was a $31 million decrease in accounts receivable.

Days sales outstanding or DSOs were 40 days as of March 31, 2013, compared to 43 days as of March 31, 2012.

In addition, our quarter-end inventory levels decreased from year-end 2012 by $10 million due to tighter working capital management.

Inventory turns for the first quarter of 2013 increased to 26x compared to 25x in Q1 2012. Capital expenditures in the first quarter of 2013 totaled $1.7 million compared to $2.8 million in 2012. Net cash provided by financing activities in the first quarter of 2013 of $1.3 million was primarily due to proceeds from the exercise of stock options.

Net sales of products drop shipped by distributors and other vendors directly to customers were 70% of total net sales in the first quarter of 2013 compared to 66% in the corresponding prior-year period.

We continue to focus on increasing drop shipments where appropriate and cost-effective, which enables us to support our customers with lower inventory levels. According to market research and announcements from other technology companies, 2013 is projected to be a challenging year. As we look to develop opportunities in 2013, we feel it is critical that we focus on our margins, cost controls and cash flow. We will now entertain your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And the first question is from Jared Schramm of Roth Capital Partners.

Jared Schramm - Roth Capital Partners, LLC, Research Division

So turning first to the federal. You mentioned that while it's only 5% of sales, it's down 29%. Is this indicative directly of sequestration there? Or just something you maybe saw start to happen later in Q4 that just carried on into Q1?

Timothy J. McGrath

I really think the federal sales was affected by the sequestration and our large contract vehicles. So we don't know when that issue will be resolved, but we're fairly confident that it will continue into Q2.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. And then staying in the Public Sector there, you mentioned state and local education were up. How are you seeing their budgets being impacted based on what you're seeing at a federal level, or is that not really something that's correlated at all?

Timothy J. McGrath

I think -- Jared, it's Tim again. I think overall, there's not that much of a correlation. So when you think about the size of our business, about 72% SLED in the quarter, about 28% fed. And we are seeing gains in education and the SLED business overall is growing. So I don't think there's too much of a correlation.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. And then turning to product mix here. As you're seeing desktop as a percentage of the total go down and being picked up by software and accessories, I guess looking out 2 to 3 years, do you have in mind where you see the total desktop sales going as a percentage of the total?

Timothy J. McGrath

Consistent with I think what we're reading in the press, there's -- I think there's a little more glimmers of hope there when we talk about the PC Plus era and some of the future for desktops. So I do think that our desktop business is up and growing. I think you're going to start to see that trend maybe offset a little bit that trend where people are concerned about desktops. However, there's no doubt that mobility is growing, tablets are growing and tablets are having a cannibalization effect on the notebooks.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And turning to SMB. One, could you highlight what you're seeing as far as that market is concerned? I think everything else is I see in this space is indicative that SMB is still a pretty tough place to plan, yet you saw some pretty decent growth there in the quarter. Any initiatives, which you're finding very successful in that market?

Timothy J. McGrath

Yes. Overall, the vertical market in SMB for health care has been very strong. We're seeing really good growth there. We're seeing really good growth in demand for our value-added services. As Technology becomes more complex, in particular, to that SMB customer that wants and needs our help and, of course, our suppliers who are looking to us to help them in the space. So it's a strong space for us and it certainly will continue to be in the future.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And excuse me if I missed it, did you provide a health care growth figure that's [ph] a part on a year-over-year basis, what you saw in the quarter?

Joseph S. Driscoll

It was a 21% health care growth and that health care is actually spread across each of our 3 segments, so you have Large Account, SMB and Public Sector all in that 21%.

Jared Schramm - Roth Capital Partners, LLC, Research Division

I think you were up in the 20-plus percent range in Q4 year-over-year, correct?

Timothy J. McGrath

That's correct. Yes.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Is that a run rate somewhere in the high-teens, mid-20s? Do you think it's sustainable looking even through 2014?

Timothy J. McGrath

It's been a significant growth area for us and every quarter last year, I think it was up 20-plus percent, got off to a great start this year. So it's been a great growth vehicle for us, with all the new changes in regulations, we think it's still going to be a positive area.

Jared Schramm - Roth Capital Partners, LLC, Research Division

In sales there, is this mainly capitalizing on the ongoing digitization of medical records or large hospital groups updating their IT platforms right now, which are quite outdated?

Timothy J. McGrath

So I think both of those, and there are a couple of other major trends driving growth there.

Jared Schramm - Roth Capital Partners, LLC, Research Division

Okay. As far as sales is concerned there, is that a dedicated segment you're breaking out from a go-to-market standpoint? Do you have a dedicated health care sales team, or is it spread across the different segments?

Timothy J. McGrath

So we do spread it across the different segments, but we do provide dedicated marketing help, dedicated training and program support. So all of our health care reps have specialization training in health care and are certified in health care and we do centralize the program, the marketing and some of the related activities there.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And my last ones here. Turning to the SG&A line, you saw some nice efficiencies there. Is that a good run rate to look forward right now as far as what we saw [ph] of SG&A in this quarter looking out for the rest of the year? [indiscernible]

Joseph S. Driscoll

So in terms of dollars, we're projecting that SG&A dollars will increase in the next 3 quarters. That's really because of the variable component of SG&A. So as our gross profit dollars are projected to increase for each of the next 3 quarters, so our SG&A does go up for that variable impact. But other than that, in terms of the percent of sales, Q1 is the worst quarter in terms of percent of sales because it's our lowest revenue quarter. So we're at about 11.2% in Q1. You'll see that percentage come down as the year progresses. So the dollars will go up, the percentage of sales will come down as the year progresses.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And then lastly here, looking at the Large Account segment, almost 3% growth there on a year-over-year basis, could you just give some high level thoughts on what you're seeing as the state of the Large Account segment? Certainly, compared where we were a year ago and where you see this, if any kind of improvement looking out, latter 2013 into '14?

Timothy J. McGrath

It's interesting. There are a lot of trends that will drive growth in the Large Account segment. I think we've talked about some of them in the past, but clearly, mobile, big data, cloud are trends that are stimulating demand for us. In Q1, a lot of our enterprise customers were really taking the opportunity to evaluate what options they're going to be engaged in going forward. And as we've also talked about, many of those are more complex. So we saw a little bit of a stall in Q1. However, we do think that the value-added services that we provide and some of the verticals that we're strong in, like health care, are really going to drive some growth in the future. So compared to a year ago, our quarter -- some of our larger accounts were more evaluating, but those accounts are good, loyal customers and their buying cycles will be back.

Jared Schramm - Roth Capital Partners, LLC, Research Division

And last one here for us, as your cash balance starts to approach $60 million, are you looking for maybe a special dividend like we saw at the end of last year? Maybe ongoing buybacks, just some thoughts on your -- what you're just doing with your cash today?

Timothy J. McGrath

Yes. I'd say, we haven't had any specific conversations about a special dividend. We'll evaluate that as the year moves along. I don't think we'll be doing buybacks at our current stock price. I guess, we like to do the buybacks when the price is sort of at book value or tangible book value or below. So we're kind of above those levels right now. But we'll evaluate all that as the year moves along. We're always looking at acquisition opportunities as another way to deploy cash. Nothing imminent on that front, but that's another way that we're looking to invest our money.

Operator

[Operator Instructions] Our next question is from Jeff Koche of Raymond James.

Jeffrey Koche

It's Jeff here for Brian. Wishes he could be on the call, he's on a flight, but I just wanted to touch on storage. It looks like you guys saw some significant weakness in that segment. I was kind of surprised. Then an area that has shown relative strength versus sort of the rest of the data center and products. I just wonder if you could talk about what happened there?

Timothy J. McGrath

Overall, our storage business is strong and there are number of components, I think, that came together in Q1. When we report the storage category, we do include hard drive, disk drives, as well as the larger systems and arrays. So it's kind of a complex category. But we are forecasting growth there. Our customers are looking to us to help them with their big data, their storage needs. As you know, the market is really growing for storage. So all those are very positive trends. In Q1, we had a few -- a very large customer that didn't repeat in a year-over-year compare and as we mentioned, Q1 overall, consistent with the industry with a little bit light in IT spend, and we expect those projects to pick up now as the year goes on.

Jeffrey Koche

Okay, great. Speaking of some large customers. Carriers, last night reported, said they had some execution issues. They lost some market share. I'm just wondering if you guys saw that -- saw any of that and how you think that -- if you did pick up some share from that, how you think that could play out for the rest of the year if they get more aggressive?

Timothy J. McGrath

Actually, we wouldn't comment on the performance of a competitor, but we can speak for ourselves and say that we don't think we're losing market share. And clearly, our business plan calls for us to continue to grow -- to grow top line growth and with bottom line profitability.

Jeffrey Koche

Yes. They said that they lost market share. I think they cited ERP issues. I'm just wondering if you saw anything tangible. Did you see it?

Timothy J. McGrath

No, we didn't see -- other than I mentioned the enterprise customers, to some degree, sort of hit the pause button in Q1, but that is a very temporary statement. And as we had discussed, our federal customers, we saw clearly a decline there. But overall, our business is up and we expect that trend will continue.

Joseph S. Driscoll

There was almost 3% growth in our Large Accounts in Q1, pretty solid quarter. Didn't really see any massive disruptions in the marketplace.

Jeffrey Koche

Okay. All right, great. And just to clarify, I think you said that -- I'm not sure if I heard it right that SLED accounted for 72% of public sales, is that correct?

Joseph S. Driscoll

Yes.

Jeffrey Koche

So, and then I think earlier, did you say that the decline in federal was roughly $10 million?

Joseph S. Driscoll

Yes.

Jeffrey Koche

So I mean, gosh, that's a massive -- I mean, if I just do the math, I mean, like 72% and that will be the federal like a little bit over $20 million in the quarter and $10 million decline, it's like 50% decline, is that accurate?

Joseph S. Driscoll

No, no. Overall, fed is 5% of our business in Q1. Federal was down 29% in Q1.

Jeffrey Koche

Okay, okay. That makes a lot more sense.

Operator

At this time, I'm showing no further questions. I'd like to turn it back over to Mr. McGrath for any further remarks.

Timothy J. McGrath

Well, thank you. I'm pleased with our performance this quarter, especially in light of the challenging environment in which we operated. PC Connection increased its sale -- excuse me, increased sales in the commercial sector by 3.8% and continued to focus on taking market share through investments and higher value-added sales. Our health care vertical was a bright spot, with a 21% increase, and software also continued to be a solid growth area. In addition, we strengthened our balance sheet and generated positive cash flow during the quarter. We believe we have the right combination of talent, experience and strategies 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 coworkers for their efforts. I'd also like to thank all of you listening to our call this afternoon. Your time and interest in PC Connection are appreciated. Have a great evening.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.

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