PC Connection Inc

NASDAQ:CNXN

Earnings Call Transcript 2019-Q1

[Operator]

Good afternoon and welcome to the First Quarter 2019 Connection Earnings Conference Call. My name is Rustin and I'll be your coordinator for today. [Operator Instructions] 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 are Tim McGrath, President and Chief Executive Officer; and Tom Baker, Senior Vice President and Chief Financial Officer. I will now turn the call over to the company.

[Unknown Executive]

Thank you, I will now read our safe harbor statement for today's call. 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 31st, 2018, 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 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.

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 on the company's website at www.connection.com. Please note that unless otherwise stated all references to first quarter 2019 comparisons are being made against the first quarter of 2018. Today's call is being webcast and will be available on Connection's website. The earnings release is also available on the website. The Form 10-K is available both on the SEC website at www.sec.gov and in the Investor Relations section of our website at www.connection.com.

I would now like to turn the call over to our host, Tim McGrath, President and CEO. Please proceed, sir.

[Timothy McGrath, executive]

Good afternoon, everyone, and thank you for joining us today to review the company's first quarter financial results. I am pleased with our strong performance in the quarter and happy to announce that net income grew by 12.6% year-over-year and we achieved record gross margins of 15.7%. The increase in both net income and margins were driven by strong growth in health care and retail vertical markets and in mobility as well as software sales including cloud migrations. In addition, we continue to tightly manage our operating expenses.

Net sales for the 3 months ended March 31, 2019, increased by 1.3% to $632.9 million compared to $624.9 million in Q1 a year ago. Our average daily sales during the quarter increased by 2.9% compared to the prior year quarter. To fully appreciate the performance this quarter, I'll remind you that cloud based and security software are recognized on net basis. These products accounted for a greater proportion of our software sales than Q1 last year causing margins to increase while at the same time creating downward pressure on our sales growth.

Gross profit increased by 3.1% to $99.3 million compared to $96.4 million a year ago. Gross margin was a record 15.7% compared to 15.4% in the prior year quarter. Gross margin was positively impacted by 27 basis points due to increased sales of cloud based and security software partially offset by changes in hardware product mix.

Now I'd like to provide a more detailed discussion of our performance by segment. In our Business Solutions segment, Q1 net sales were $252.9 million representing a decrease of 3.9% compared to $263.3 million a year ago. Gross margin for this segment increased by 23 basis points to 17.8% in the quarter. Our Business Solutions segment margins benefited from the mix of software sold and an increase in the mobility business, which grew by 12.8% in the quarter. This category continues to benefit from project refresh including the expiration of Windows 7.

In our Public Sector Solutions business, Q1 net sales were flat at $104.4 million compared to a year ago. Sales to the Federal Government increased by 3.3% compared to the prior year, while sales to the State and Local government and educational institutions decreased by 1.7%. Gross margin for the segment decreased by 29 basis points to 12.6%, primarily due to a competitive demand environment.

In our Enterprise Solutions segment, Q1 sales were $275.6 million, an increase of 7.1% (sic) [ 7.2% ] compared to $257.2 million a year ago. Gross margins for this segment increased by 69 basis points to 15%. The Enterprise Segment continued to benefit from large project refreshes and vertical markets solutions. This combination drove strong growth in accessories, displays, networking and desktops, which grew during the quarter at 45%, 22%, 18% and 15% respectively.

In addition, we continue to benefit from cloud based software and security migrations.

Having covered our sales and gross margin performance, I will now turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statement. Tom?

[Thomas Baker, executive]

Thanks Tim. SG&A increased this quarter to $81.2 million from $80.9 million a year ago. However, SG&A as a percentage of sales decreased by 11 basis points year-over-year demonstrating our commitment to managing our operating expenses. In Q1, we've incurred $703,000 of restructuring costs associated with the reduction of some of our internal resources and other exit costs associated with the closing of a facility. These charges are presented as a separate line item in our income statement.

Our operating income increased 12.5% this quarter to $17.4 million from $15.5 million a year ago. Our effective tax rate was 27.7% up from 27.5% in the same period a year ago. Net income for the quarter increased 12.6% to $12.7 million from $11.3 million last year. Earnings per basic and diluted share were $0.48, an increase of 14%. Earnings per share adjusted for the restructuring and other charges was $0.50 compared to $0.42 last year. Our trailing 12-month adjusted earnings before income taxes, depreciation and amortization, or adjusted EBITDA increased 10% to $108.1 million from $98.6 million a year ago.

We repurchased 43,000 shares during Q1 for $1.3 million at an average cost of $30.44 per share. We ended Q1 with $93.5 million of cash and cash equivalents representing an increase of $22.5 million from the prior year. In Q1, the company adopted the new leasing standard, which requires lessees to recognize right of use assets and a corresponding lease liability on its balance sheet for all leases with terms longer than 12 months. As a result, we recorded a right of use asset of $18.7 million and lease liability of $18.8 million on January 1, 2019. This adoption had no impact on the earnings of the company.

Cash flow from operations was $18.1 million versus $37.2 million for the same period a year ago. The change was primarily driven by the timing of changes in working capital. Investing activities of $6.6 million for the quarter were primarily the result of equipment purchases and capitalization of our ERP system upgrade that is in process.

The company used $9.8 million of cash for financing activities during the quarter consisting of the Q1 payment of $8.5 million for our previously declared 2018 special dividend and the aforementioned $1.3 million of stock repurchases. As of March 31, 2019, we have $26.1 million remaining for stock repurchases under our existing stock repurchase program.

Moving to capital expenditures, during Q1 we capitalized $4.8 million, which was mainly used to fund our ERP system upgrade that is currently in progress. We expect our total remaining spends for this project including capitalized costs to be in the range of $3 million to $4 million over the next three to six months.

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

[Timothy McGrath, executive]

Thanks, Tom. IT products and Solutions continue to evolve as customers are using technology to transform and secure their businesses. Q1 is typically our lowest quarter for large project refresh. Based on the timing of these rollouts, we did see some lumpiness in our product categories. I'm pleased with our performance in vertical market solution sales. We experienced significant growth in retail and in health care. The continued growth in our Enterprise Segment was a major contributor to our vertical market success in Q1. Customer's acceptance is measured in many ways and enabled by advanced technologies. We'll continue to invest in systems and subject matter experts in order to help our customers improve productivity, enhance growth and empower innovation. We're optimistic about the opportunities we have to assist our customers and transforming their business. We continue to see strong growth by helping our customers create competitive advantages with technology. In today's modern IT environment, we deliver solutions that are usually part of a project rollout. These large project rollouts will ebb and flow based on our clients' business driven need. In Q1, these types of projects skewed our product mix. Our business is strong and our forecast remain intact. We believe that our team and the strategies that we have in place position us well to gain market share and increase long-term shareholder value.

We'll now entertain your questions. Operator?

[Operator]

[Operator Instructions]

Our first question comes from the line of Adam Tindle from Raymond James.

[Madison Suhr, analyst]

Good afternoon. This is Madison on for Adam. I wanted to start on Enterprise Revenue that was pretty strong. Can you talk about what's driving the growth in Enterprise? We just heard from a competitor talking about weakness in that market and then how should we think about growth and profitability of the segment going forward?

[Timothy McGrath, executive]

Madison, thanks for joining us. Yes, so when we think about our Enterprise Business, there's no doubt as we mentioned that it is large project rollout dependent and in Q1, we really benefited from the software categories and mobility categories in particular. And that probably stems from those projects that started in prior quarters that were data center upgrades that are now moving out toward more of the client and edge components. So in addition to those categories, we also saw strong growth in some of the edge accessories in that part of the business. So we feel pretty confident that going forward for the Enterprise, we're going to continue to see good growth. We think about Q2, we've got a lot of drivers of that growth. As you know, it's Microsoft's year-end. We see customers that are still upgrading and refreshing, some just pure project refresh, some based on software, the expiration of Windows 7, all driving good growth for the Enterprise.

[Madison Suhr, analyst]

Okay, that's helpful. And then one for Tom, if I could. So historically, the playbook has to run the business in the net cash position and then pay a special dividend at the end of the year. As CFO, how do you think about capital allocation and the right capital structure for the business?

[Thomas Baker, executive]

Yes, I think we're going to sit back, look at the opportunities we have in front of us for investment and we will allocate capital for those projects that we think are going to benefit shareholders the most in the long term. As you noticed last year, we did some investment and we took down special dividend a little bit. We -- we're going to adjust accordingly as time goes by.

[Operator]

[Operator Instructions] I am showing no further questions at this time. I would now like to turn the call back to Tim McGrath.

[Timothy McGrath, executive]

Thank you, operator. 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 also like to thank all of -- all of you who are listening to the call this afternoon, your time and interest in Connection are appreciated. Have a great evening.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.