PC Connection Inc

NASDAQ:CNXN

Earnings Call Transcript 2020-Q4

[Operator]

Good afternoon and welcome to the Fourth Quarter 2020 Connection Earnings Conference Call. My name is Josh, and I'll 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 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.

[Samantha Tracy, Investor Relations]

Thanks, operator. I will now read the Safe Harbor statement. 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 year ended December 31 2019, as updated in the Form 10-Q for the period ended September 30, 2020, each of 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 fourth quarter 2020 comparisons are being made against the fourth quarter of 2019. Today's call is being webcast and will be available on Connection's website. The earnings release will be available 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. Tim?

[Tim McGrath, President & Chief Executive Officer]

Thank you, Samantha. Good afternoon, everyone, and thank you for joining us today for Connection's Q4 2020 conference call. We're pleased to announce that our Q4 results reflect continued sequential improvement in our business, consistent with the recovery trend we've seen since late in the second quarter. In Q4, we experienced year-over-year revenue growth in two of our three sales segments: Business Solutions and Public Sector. Our year-over-year growth in these two segments was offset by a decline in Enterprise Solutions, which had a strong Q4 in 2019.

Fourth quarter revenue was $675.7 million, down 5.7% from 2019. Gross profit of $108.9 million was down 6.2% and average daily sales decreased by 4.2%. Gross margins of 16.1% were essentially flat year-over-year. Operating income was $19.8 million, a decrease of 33.3%, or 2.9% of net sales, compared to $29.6 million or 4.1% of net sales in the prior year quarter. In Q4 2020 diluted earnings per share was $0.62, a decrease of 25.3% from Q4 2019. We ended Q4 with $95.7 million of cash and cash equivalents, representing an increase of $5.6 million from December 31, 2019. The net income and earnings per share drop from 2019 is obviously disappointing, reflecting a challenging 2020, a tough comparison from a strong year for our Enterprise business in Q4 2019, lingering but declining ERP transition costs, unusual one-time legal costs related to a commercial dispute and expenses related to introducing a new technical sales force, which we believe will drive revenues this year and beyond.

Looking at our segment performance; despite pandemic-related headwinds, our Business Solutions segment achieved organic growth in the quarter for the first time since Q1. Q4 net sales were $265.2 million, an increase of 1.1% compared to $262.3 million a year ago, while average daily sales increased by 2.7% in the quarter. Gross profit in the Business Solutions segment was $50.7 million, a decrease of 3.7% from a year ago. Gross margin decreased by 95 basis points to 19.1% in the quarter compared to 20.1% in the prior year as a result of changes in product mix. In our Public Sector Solutions business, Q4 net sales were $134.9 million, an increase of 1.8% compared to $132.5 million a year ago. Sales on an average daily basis grew 3.5% in the quarter. Sales to state and local government and education institutions was $95 million, an increase of 23% compared to the prior year. An increase in the SLED business was largely the result of increased sales across higher-ed, K-12 and state and local governments. After experiencing growth of 25.4% in Q4 2019, sales to the federal government declined as we experienced fewer large project rollouts in the quarter. Revenues were $39.9 million, 27.8% lower than Q4 2019.

Gross profit for the Public Sector was $18.5 million, a decrease of 11.6% compared to Q4 '19. Gross margin decreased by 209 basis points to 13.7% due to changes in product mix and vendor incentives. We expect margins to normalize in the months ahead as our revenue recovers. We are focused on returning the federal business to historical levels of performance.

In our Enterprise Solutions segment, Q4 sales were $275.6 million, a 14.4% decrease compared to $321.9 million a year ago, or a 30% decrease on an average daily sales basis. Gross profit for the Enterprise segment was $39.7 million, a decrease of 6.7% in the quarter, which helped drive an increase in gross margin for the quarter of 118 basis points to 14.4%. In addition to a difficult year-over-year comparison, during the quarter, the Enterprise sales pace experienced challenges with product availability issues with a few of our large suppliers. Perhaps the silver lining, the Enterprise Solutions segment has experienced continuous growth since Q2, and actually ended the quarter with the highest backlog in their history. We expect it will take a couple of quarters for this backlog to normalize.

Let me turn the call over to Tom to discuss additional financial highlights from our income statement, balance sheet and cash flow statement.

Tom?

[Thomas Baker]

Thanks, Tim. SG&A was $89.1 million this quarter, an increase of 3% from $86.5 million a year ago. As a percentage of net sales, this represented an increase of 112 basis points year-over-year and slightly down from Q3. The year-over-year Q4 increase in SG&A amounting to about $0.10 per share was driven by continuing professional fees associated with the ERP rollout, one-time legal fees related to a commercial dispute and costs associated with establishing a new technical sales force. Sequentially, the ERP spend declined as planned and we will reduce the ERP spend by over 50% in Q1. So, we're trending in the right direction here.

Q4 operating income was $19.8 million, down 33.3% this quarter from $29.6 million a year ago. Our effective tax rate was 21.7%, down from 26.5% in the same period a year ago. Included in the current quarter's tax expense is favorability from certain tax exempt insurance proceeds and a benefit from an R&D tax credit. Going forward, we expect the tax rate to revert back to the 28% range. Net income for the quarter was $16.3 million, a decrease of 25.8% from $22 million a year ago. The diluted earnings per share was $0.62, a decrease of 25% from the prior year period. Our trailing 12-month adjusted earnings before income taxes, depreciation and amortization, or adjusted EBITDA, decreased 30% to $90.6 million from $128.7 million a year ago.

In Q4, we declared a $0.32 per share special dividend, which was paid in January of this year, returning $8.4 million to shareholders. In addition, during 2020, we repurchased 247,000 shares for $10.2 million. Between the special dividend and the stock repurchase, a total of $18.6 million of cash was returned to shareholders in 2020. We have $12.7 million remaining for stock repurchases under our existing stock repurchase program.

Cash flow from operations for the year ended 2020 was $36.1 million versus $36.6 million for the same period a year ago. The change was driven primarily by an increase in accounts payable, offset by an increase in accounts receivable and inventory. DSO for the quarter improved sequentially for both the Business Solutions Group and Public Sector Group by 7%. However, this was offset by an increase in the DSO in the Enterprise Group. The increase in the Enterprise Group DSO was almost entirely due to increased software sales, for which revenue is recognized on a net basis.

Our net cash used in investing activities of $11 million was primarily the result of equipment purchases and IT initiatives. The company used $19.5 million of cash for financing activities during the year, consisting primarily of the Q1 payment of $8.4 million for our previously declared 2019 special dividend and $10.2 million of stock repurchases.

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

[Tim McGrath, President & Chief Executive Officer]

Thanks, Tom. As we move into 2021, we are optimistic about our future, building upon the efforts we've made during a challenging 2020 to position us for success. There were a number of notable accomplishments. I'd like to take a minute to review some of these. We believe we had industry-leading growth in health care during 2020. Our manufacturing vertical grew by 31% for the quarter. The SLED business grew by 23% in Q4. We grew our Technical Solutions Group and lifecycle services business by 27.5% for 2020. And we received several awards from our partners, including HP National Solution PC Partner of the Year, Intel innovation Partner of the Year and Microsoft US Partner of the Year for Surface PC. In addition, we added a record number of new customers during the pandemic.

Moving forward, we expect that we can grow revenue 200 basis points to 300 basis points in excess of the market rate of growth. In terms of our operating expenses, we continue to focus on driving costs out of the business and improving our operations. We remain confident that we are very well positioned to meet customer needs going forward. Demand over the past year for software-as-a-service was strong, and we expect continued growth in workplace transformation, cloud, security and managed services through our Technology Solutions Group. Obviously, the pandemic had a significant impact on our business and our customers in 2020. We're optimistic about 2021, and look forward to continuing to deliver the service and performance our customers expect and the financial performance our shareholders deserve.

We'll now entertain your questions. Operator?

[Operator]

Thank you. [Operator Instructions] Our first question comes from Anthony Lebiedzinski with Sidoti & Company. You may proceed with your question.

[Anthony Lebiedzinski, Sidoti & Company]

Good afternoon. And thanks for taking the questions. So first, I just wanted to see if you guys could perhaps maybe quantify what you feel out there with the impact from supply chain constraints on your business in terms of revenue?

[Tim McGrath, President & Chief Executive Officer]

Anthony, thanks for the question. You blanked out a little bit. Could you repeat that?

[Anthony Lebiedzinski, Sidoti & Company]

Sure. Yes. So, I was asking about the supply chain constraints. Is there any way that you guys could quantify perhaps how much of an impact that had on revenue?

[Tim McGrath, President & Chief Executive Officer]

Yes. We don't have that specifically broken out as it ebbs and flows. But as you know, Anthony, the work from home, the growth that we're seeing across the entire industry has really exacerbated demand for mobility displays, CPUs and ICUs across the industry and where we had large project rollouts towards the end of the quarter, some of them were delayed specifically for that reason. So, I do not think it's unique to us. I think it's industry-wide. And I'm pretty optimistic that, while it will take us a couple of quarters to resume to normal, that we'll be right back on track.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. Okay. Thank you for that, Tim. So as far as SG&A, you called out the -- some of the increases, Thomas, as far as the ERP system is concerned. You also have this new technical sales organization, which I would love to get a little bit more details on as far as that and then the one-time legal fees. So, is there a way for you guys to -- for you to kind of break down? Basically, I want to get a sense as to what's recurring type of normal expenses versus going forward? Obviously, some of this was kind of one-off, but is there any way you guys could quantify some of these SG&A expense pressures?

[Thomas Baker]

Yes. Let me give you a couple of data points, Anthony, just to start out with. So if I look at our G&A rate as a percentage of revenue from Q4 last year to Q4 this year, I think it's up 110 basis points. That increase is a function of two components. Component number one, which accounts for about 50 basis points to 55 basis points is simply the software netted, right. We've got a lower revenue base. So if you strip that out, our actual G&A rate is up about 60 basis points on the year. And that is based entirely due to these one-time costs, which were roughly -- I'd say, most of them were one-time cost. Let's say, it's $2.8 million of ERP, $800,000 of ERP legal stuff and $500,000 for -- $800,000 for the commercial legal dispute and $500,000 of kind of other lingering things. That kind of quantifies what the increase is. Now, next quarter, not all of that ERP stuff is going to go away, the $2.7 million I mentioned. It's probably going to be sub $1.3 million, would be my guess -- is my current forecast. So hopefully, I've given you a little bit more specificity than usual just because there is a little bit -- a lot of few moving parts here.

[Anthony Lebiedzinski, Sidoti & Company]

Okay. Yes. Thank you, Tom, for that. And then would you expect additional ERP system expenses beyond Q1?

[Thomas Baker]

I think beyond Q1, it's kind of [ph] going to be at the noise level and would kind of be in the more than normal maintenance mode that we've been in historically. So, I don't think it's going to be anything of significance that it's going to need to have further conversations about it.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. Thank you. And then last question for me is, so, Tim, you mentioned that you are optimistic about 2021. Can you go over three main statements [ph] as to how we should think about the progression of your business through the year you would expect? I'd just be curious to get your thoughts on that.

[Tim McGrath, President & Chief Executive Officer]

Yes. Well, thanks, Anthony. When you think about 2020 as a base, the abnormality there was simply this, Q1 in 2020 for our industry was the largest quarter of the year. And of course, that's completely out of alignment with what we're used to. And so as we start to move through the pandemic and as the vaccine is more available and people start to return to work, albeit on a hybrid basis, we think that we're going to see a continued recovery starting in Q1, but then moving through Q4. So that Q3 -- really Q4 should be our best quarter of the year. We will return to more of a normal, I think, in our course.

[Thomas Baker]

I think, Anthony, the thing I have been struggling with what's Q1 is going to look like, right? And where last year was kind of an abnormality, a little bit higher than normal. When you go back in time and you look at that Q4 to Q1 transition, it's typically in the high single-digit, down 8%, 9%. I kind of think that's -- and I don't know why there is going to be much different than that. It's definitely hard to model off Q1 last year because we did have that surge in March.

[Anthony Lebiedzinski, Sidoti & Company]

Got it, okay. And would you expect those gains -- as we get past the Q1 noise, would you expect that sales gains be kind of more even across the different segments? Or would you say that you'd expect greater revenue growth in, let's say, Public Sector versus Enterprise? Or how should I think about that?

[Tim McGrath, President & Chief Executive Officer]

So I think, Andrew, the way to think about that really is to -- as we look at the second half of 2021, the wildcard here is we need the recovery around the pandemic and we need the supply chains to normalize. And so, clearly, the second half of the year should be better than the first half from a revenue and a growth perspective. In terms of enterprise growth, we are optimistic. What we saw in 2020 was many, many large enterprise focused on selling their people home and anything from home was an uptick for 2020. In '21, we do think many of those data center projects will return. Some of those that were delayed in 2020, we'll see in '21. So, we're pretty optimistic that the enterprise will recover. That is really a second-half statement for us. When it comes to our small and medium business, the Business Solutions team, we think that will be kind of a steady progression as small business starts to come back and build their way back from the pandemic.

And then, with the public sector, we expect Enterprise, K-12, higher-ed to be strong and the federal business should come back. As a matter of fact, we're already seeing a much higher backlog and a much higher order rate there. But that we think will progress through the year as well. So, our best guess is and it really is a guess at this point, we'll start to see normal seasonality, but we've got to say that when the pandemic is behind us.

[Anthony Lebiedzinski, Sidoti & Company]

Got it. All right. Well, thank you and best of luck.

[Tim McGrath, President & Chief Executive Officer]

Thank you.

[Thomas Baker]

Thanks, Anthony.

[Operator]

Thank you. Our next question comes from Adam Tindle with Raymond James. You may proceed with your question.

[Catherine Huntley, Raymond James]

Hi, this is Catherine Huntley on for Adam. Thanks for taking our questions. Our first question has to do with current trends. We've heard from other competitors that bookings are increasing year-over-year in 1Q and have rebounded. So, can you please talk about the trajectory that you've seen in your company for your bookings as we sit here in late February?

[Tim McGrath, President & Chief Executive Officer]

So thanks, Catherine. We are clearly seeing an uptick in bookings. When we look at our bookings year-over-year, they are definitely trending up. Q1, as Tom mentioned, is a little bit of a tough compare because as you know, we really started to see the work-from-home products kick in, in late February, early March of 2020. So that -- those products are a little tougher to compare. But clearly, bookings are up across the board and we do anticipate a recovery coming in '21. But we've modeled that out and we are kind of sticking with our model, which is, we think the market rate of growth, plus 200 basis points to 300 basis points is the appropriate way to build that into your model in terms of our overall growth.

Tom?

[Thomas Baker]

I think that's spot on.

[Catherine Huntley, Raymond James]

Thank you for the color. And as you look into the second half of 2021, how do you think about the potential decline in devices versus the increase in data center projects? Do you think that's net-neutral, net positive, negative?

[Tim McGrath, President & Chief Executive Officer]

That is a great question. Let me provide what color I can. The first is that we still believe, the whole workplace transformation is going to be strong. We think there are great drivers of that. For example, when you think about the work from home, work from anywhere, learns from home, there are good reasons to continue to upgrade. If you look at connectivity, 5G and WiFi 6 is going to be a driver. If you look at collaboration there will be better built in collaboration tools to enable video conferencing. So, all of those combined with the need to have more data, more video are still drivers for upgrading mobility. So, we think that will be fairly strong throughout the year, but obviously will tail off towards the back half of the year. And we do think that will be replaced with data center projects. Many of those were delayed. And so we think there will be a little bit of a transition that happens in the second half of the year more toward data center and advanced technologies.

[Catherine Huntley, Raymond James]

Okay, awesome. And then, just an update on ERP. Can you update us on the transition and benefits you're seeing? In the previous question, you mentioned that their increase is short term. But are there any elevated costs that may come longer term? Or when can we see those costs start to mitigate out?

[Thomas Baker]

So, what -- I think what you're going to start to see here is our transition costs are going to be pretty inconsequential post up -- post Q1 is the plan. I think after that standpoint, after that point, we'll get things normalized. We will start to see some efficiencies come through. And in terms of the increased costs, there was an increase in some depreciation started last year, but that's currently in our current run rate. So, I don't think there is a lot there. Obviously, the goal here is to grow the business without growing the overhead. And that's what we intend to leverage the system to help us build.

[Tim McGrath, President & Chief Executive Officer]

Right. When you think about the benefits, the system is more expandable. It opens up opportunities around acquisition. It's more robust. It's more secure and it offers more capabilities that will have to be fine tunings throughout the year. But clearly, there's a lot of upside for an ERP transition like this one.

[Catherine Huntley, Raymond James]

Okay, thank you so much. And congrats on the quarter.

[Thomas Baker]

Thank you.

[Operator]

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Tim McGrath for any further remarks.

[Tim McGrath, President & Chief Executive Officer]

Well, thank you, Josh. I'd like to thank all of our customers, vendor partners and shareholders for their continued support and once again, our dedicated coworkers for their efforts and extraordinary dedication through this time. I'd also like to thank those of you who are listening to the call this afternoon. Your time and interest in Connection are appreciated. Have a great evening.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference call. Thanks for participating. You may now disconnect.