PC Connection Inc

NASDAQ:CNXN

Earnings Call Transcript 2017-Q4

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Fourth Quarter 2017 Connection's Earnings Conference Call. My name is Amanda and I will be your 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 Connection and may not be recorded or rebroadcast without specific permission from the company.

On the call today is Tim McGrath, President and Chief Executive Officer; and Colin McGuinness, Director of Accounting and Financial Reporting. Unfortunately, Bill Schulze, our Interim CFO is unavailable to attend today's call.

Any statements or references made during the conference call that are not statements of historical facts, may be deemed to be forward-looking statements. In particular, various remarks that management may make about the company's future expectations, plans, and prospects, constitute forward-looking statements for the 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, 2016, 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 views 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. Today's call is being webcast and will be available on Connection's website. The earnings release is also available on the website.

I would now like to turn the call over to Tim McGrath. Please proceed, sir.

[Timothy McGrath, President and Chief Executive Officer]

Thank you. Good afternoon everyone and thank you for joining us today to review the company's fourth quarter financial results. As we review our results, please note that unless otherwise stated, all of our fourth quarter 2017 comparisons are being made against fourth quarter 2016.

Net sales in the fourth quarter grew by $27 million or 4% to a record $762 million, led by 7.6% growth in business solutions and 7.2% growth in enterprise solutions. We also saw strong growth in the vertical markets of retail, manufacturing, and finance. Q4 was a strong quarter for our Business Solutions segment which serves small-to-medium sized businesses. We saw growth in both client devices and advanced technology. Sales for this segment grew 7.6% to a record $298 million.

Desktop revenues grew 31% and mobility grew 7%. The client device refresh continues for the fourth straight quarter as SMB customers upgraded in an effort to increase productivity and enhance security. Advanced technology which includes converged data center products, services, and software also grew in the quarter. Although net common [ph] store sales declined server sales increased 26% and software grew 15%.

In total, advanced technology sales represented a record 48% of overall sales for business solutions. Sales of enterprise solutions businesses large account grew 7.2% to a record $309 million. Our enterprise customers increased their IT investments in the quarter driven by large project rollouts. In addition, Q4 software revenues grew 16% and storage grew 37%. Client devices grew 6% and represented 30% of overall revenues for the large account segments.

Consistent with industry trends, we're seeing companies looking to transform their business with technology and a digital first strategy. For example, work force productivity is driving a client device refresh. In addition, we strong growth in service and managed services. Sales for public sector solutions decreased by 9% to $155 million. Our federal business declined by 12% although this is measured against sales in Q4 of 2016 which were unusually strong. The increase in sales last year was largely due to one federal government customer which did not repeat. Our sales of state and local governments and education or SLED customers decreased by 5% due to a strong competitive landscape.

Consolidated gross profit dollars in the quarter increased by $1.4 million to $99.5 million. Consolidated gross margin was 13.1% compared to 13.3% in Q4 2016. The low margin was primarily the result of the sales mix driven by client refresh and the ongoing competitive marketplace. Gross margin for our Business Solutions segment was 15.6% compared to 15.7% last year and 14.9% in Q3 2017. We're pleased with the sequential increase which was primarily due to higher vendor consideration in Q4.

Gross profit dollars for Enterprise Solutions increased over last year by $1.2 million while selling margins decreased by 43 basis points to 11.7%. The decrease in the margin rate was due to the continued competitive marketplace and large account device refresh. Gross margin for Public Sector year-over-year decreased by 56 basis points due to the highly competitive marketplace for both the federal busy season and the higher education space.

Now let me share with you the power in our business model with a couple of examples on how we provide end to end solutions in vertical markets. First, an example of how the customer improved their productivity. In Q4 we helps a large hospital upgrade their central ambulatory system along with their technology refresh. This included workflow assessment, device assessment, and consulting that ultimately helped them to be more efficient and more competitive. In the process we delivered laptops, servers, storage, networking, consulting services and wireless technologies.

In another case, we're empowering innovation. We also helped a global healthcare company design hardware, software and services along with their Windows 10 refresh. In the process we provided project management, staff augmentation, onsite helpdesk and a global delivery system using one source our global solution. We are passionate about helping our customers improve their businesses with technology.

SG&A including special charges increased slightly in the quarter to $94.9 million from $94.7 million last year. You may recall that in Q2 we introduced additional operating expense disciplines which were offset by higher sales compensation in Q4. We continue to monitor costs in this uncertain macroeconomic environment. This discipline should enable us to continue to invest in our mission critical growth areas of the business.

You may have seen our press release from last week which we announced that we awarded a cash bonus of $1000 to each nonexecutive employee in consideration for their efforts for the year ended December 31, 2017. In Q4 2017 we recorded a special charge of $2.7 million for this one-time bonus and related payroll taxes.

In December, the U.S. tax cuts and job act was enacted which among other changes reduced our going forward federal income tax rate. Historically our combined federal income tax rate has been approximately 40%. Although we're still evaluating the various impacts of the new legislation, we estimate that our combined effective tax rate for 2018 will range from 27% to 29%.

This rate reduction also required the company to adjust its net deferred tax balance for the fiscal year ending December 31, 2017. As a result of the adjustment, the company recorded a non-cash income tax benefit of $7.7 million in the fourth quarter of 2017. Including the cash bonus and tax benefit, net income for the quarter was $20.7 million an increase of $7.7 million compared to $13 million last year.

Overall, our financial performance was solid. Diluted earnings per share was $0.77 compared to $0.49 last year. Excluding the impact of the one-time bonus and income tax benefit, our adjusted earnings per share was $0.54 compared to $0.52 last year. In addition, our 2017 adjusted EBITDA was $94 million.

In Q4 we declared a $0.34 dividend which were paid mid January and returned $9 million to shareholders. Our balance sheet is strong as we continue to be debt free. We ended the quarter with $15 million in cash, days outstanding was 48 days and inventory turns was 24. Our goal is to maximize shareholder value while maintaining financial flexibility. We continue to assess M&A opportunities and other capital allocations such as dividends and stock buybacks.

As a reminder, we still have approximately $18 million in previously authorized share repurchases.

2017 was a solid year for revenue growth. As mentioned earlier, we saw strong growth in vertical markets particularly retail, finance and manufacturing. Moving forward we'll continue to make investments in our operational efficiencies and our improvements.

For example, earlier in the year we realigned our workforce and formed a dedicated ecommerce organization. We launched our new website, www.connection.com and we saw double-digit growth in our ecommerce business. This new website enables our customers to place frictionless orders that require lot of human touch for us and result in greater productivity for them and a better overall customer experience.

We remain focused on advanced technologies and building our [indiscernible] capabilities. We're investing in complex areas of the business including software defined data center, hybrid cloud, digital workspace, managed services and security. Our software business continues to growth including cloud, virtualization, security and security assessments.

We believe our business model is more relevant than ever as we help our customers navigate through technology that's more complex and more disruptive. We have expanded our capabilities and enhanced our automated sales tools. We believe that our balance portfolio of customers, suppliers, products and solutions have positioned us well for the future. Our goal is to continue to deliver sustained and consistent performance.

I was pleased to see continued growth in our four strategic vertical markets; manufacturing, retail, healthcare and finance. We also saw strong growth in software and workforce productivity during the quarter. We believe our team and the strategies we have in place positions Connection well to gain market share and increase long-term shareholder value.

We will now entertain your questions. Operator?

[Operator]

Thank you. [Operator Instructions] Our first question is from the line of Adam Tindle of Raymond James. Your line is open.

[Adam Tindle, Raymond James]

Okay, thanks and good afternoon. I just wanted to start on the competitive environment Tim. I think in the press release you talked about an ongoing competitive environment in the public sector and large enterprise, but that comment wasn’t on the SMB space. So just wondering if you can maybe bifurcate where you are really seeing the competitive environment intensify? And then also kind of moving forward, do you think that gets better? What are the moving pieces to that improving?

[Timothy McGrath, President and Chief Executive Officer]

Well thanks Adam. So I think the competitive environment is really across all three of our sales subsidiaries, but it's definitely more intense at enterprise and in the federal space. So we have seen large bids driving some hyper competition there. I think that it's leveled out and I think as we drive into 2018 we're going to continue to see the competition show up and be very aggressive.

But I also think our solutions capability combined with some of the plans we have in place to be more efficient are going to bode well for us. So I think we're up to a reasonable start for the year, but we still are a little unknown when it comes to predicting whether or not that hyper competitive landscape will level out or even decline a little.

[Adam Tindle, Raymond James]

Okay that's fair and I guess maybe on gross margin in 2018, maybe it's a little bit too early to tell, but as you kind of mix up, find the right mix, solutions mix, the competitive environment, some of your competitors are kind of talking about flat to down gross margin. I just wondered if you had any view on how we could think about that line in 2018?

[Timothy McGrath, President and Chief Executive Officer]

Yes, well thanks, so it’s an interesting question given the history that we had in 2017 also in reports much like Raymond James report, it’s interesting to see our server business really grow. We're seeing growth in advanced technologies and the margin hasn't yet followed the way that we'd like it to. So we also are looking at a flat to slightly down margin environment for 2018.

[Adam Tindle, Raymond James]

Okay and that's fair and maybe one last one, what you have done is done a nice job of controlling SG&A. As we think about 2018 do you think you're in a position where gross profit dollars could continue to outpace SG&A because I know you talked about wanting to make some investments there, so just trying to get a sense for if there's operating leverage as we think about 2018? Thanks, Tim.

[Timothy McGrath, President and Chief Executive Officer]

Yes, there is no doubt. Thanks. We're going to manage that very closely and clearly we need gross profit dollars to increase faster than SG&A, so we're going to keep the range pretty tight there and that is absolutely the plan today.

[Adam Tindle, Raymond James]

Thank you.

[Timothy McGrath, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. [Operator Instructions] Our next question is from the line of Anthony Lebiedzinski of Sidoti. Your line is open.

[Anthony Lebiedzinski, Sidoti]

Yes, good afternoon and thank you for taking the questions. So just to follow up as far as the different competitive dynamics within each of the segments, so it sounds like the SMB is kind of more insulated I guess from the competitive pressures. So with that said, would you be looking to focus more resources on trying to expand the SMB segment to capture that?

[Timothy McGrath, President and Chief Executive Officer]

Well, thanks Anthony. So let me hit each segment kind of wanted time for SMB 48% of revenue did come from advanced technology. So we're seeing good success there selling across the solutions stack. So we're optimistic about that and our team has been a great performing team. But in the enterprise space we're also seeing really high growth. We've got a strong pipeline in place and we're making investments there to drive solutions. Because at the end of the day it is our customer and our customers’ requirements that really fuel our need to add investments and to help them solve their business challenges.

So we'll continue really across the board increasing our capabilities and what we call advanced technologies and that is also true for public sector. We're very bullish on the higher ad space for the rest of the year and we're optimistic overall in the government space, both SLED and Fed based on some of the tax law changes and some of the infrastructure plans that are in place.

[Anthony Lebiedzinski, Sidoti]

Okay, that's very helpful. So when you look at a different vertical markets that you're in, which ones you think has the most growth potential in 2018 and which ones you think would be the most challenged?

[Timothy McGrath, President and Chief Executive Officer]

So, I think the most challenge is going to be able to do the sort of reverse order Anthony. The most challenged will be healthcare and that's really based on I think the administration and I think the uncertainty around what's going to happen based on the administration and healthcare. So I think that we see healthcare really leveling off; however, we're seeing significant double-digit growth in both manufacturing and retail.

From a manufacturing perspective you've heard it I'm sure you know we really are in the fourth industrial revolution. We're seeing really all facets of manufacturing change and that is really being driven by digital first approach, from the Internet of Things to 3D printing to artificial intelligence, robotics, everything coming together there that space is really rapidly changing and we have to enable that change.

So we're excited about that. We're seeing great growth in retail and the technologies enabling retail and retail doing kind of an end-to-end digital approach as well. So both of those verticals are very strong. And then finally trailing that somewhat not quite as strong we think the financial vertical is poised to grow as they are right for upgrade as well. So, I would say manufacturing retail highest growth followed by finance and we kind of include education as a vertical as well, so education and then definitely a slowdown in healthcare.

[Anthony Lebiedzinski, Sidoti]

Got it, okay. All right, well thank you very much.

[Timothy McGrath, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. And at this time I'm showing no further questions. I'd like to turn the conference back over to Mr. Tim McGrath for the closing remarks.

[Timothy McGrath, President and Chief Executive Officer]

Well, thanks. 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 everyone listening to our call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.