Timothy J. McGrath - Chief Executive Officer and President Joseph S. Driscoll - Chief Financial Officer, Principal Financial & Accounting Officer, Senior Vice President and Treasurer.

Prabhakar Gowrisankaran - Canaccord Genuity, Research Division Jeff Martin - Roth Capital Partners, LLC, Research Division R. Scott Tilghman - B. Riley Caris, Research Division.

Good afternoon, ladies and gentlemen, and welcome to the Third Quarter 2014 PC Connection, Inc. Conference Call. My name is Liz, and I will be the coordinator for today. [Operator Instructions] As a reminder, this conference call is a 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 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 seen the press release, you can contact Janice Rush at (603) 683-2322, and she will e-mail a copy to you.

Today's call is being webcast, and both the press release and webcast will be available at the Investor and Media Center page at PC Connection's website. I would now like 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 third quarter financial results. We are pleased with our strong third quarter performance. Our sales, net income and earnings per share were the highest quarterly results in the company's history. Net sales grew by 10.2%.

This was our third consecutive quarter of double-digit growth. IT spending trend by our business customers continue to be strong. And our Education business had another excellent growth quarter for both K-12 and higher education. We grew earnings faster than sales as net income and diluted earnings per share both increased by 15% in the quarter.

We continue to execute our core growth strategies to deliver a broad spectrum of IT solutions. Our goals are to increase market share, invest in higher margin technical solutions capabilities, enhance operational efficiencies and maximize growth opportunities in targeted vertical markets.

As we review our results, please note that unless otherwise stated, all of our third quarter 2014 comparisons are being made against the third quarter of 2013. Consolidated net sales increased year-over-year by $59 million or 10.2% to $640 million. Gross profit dollars increased by 9% to $84 million.

Gross margin was slightly lower than the prior year at 13.1%. The product mix shift to lower-margin notebooks and desktops was partially offset by strong performance in software and servers, which are higher-margin categories. Net income for the quarter increased by 15% to $12.2 million, and diluted earnings per share increased from $0.40 to $0.46.

Earnings grew faster than the rate of sales growth due to the leveraging of our fixed costs over higher net sales. Operating income, as a percentage of sales, increased to 3.2% in Q3 versus 3% in the prior year. And now I'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-sized businesses increased by 8.1% to $254 million, with double-digit percentage increases in the notebook and desktop/server categories. [Audio Gap] Margin increased significantly from 12.1% to 13.1%.

Our overall commercial sales, which are the combination of our SMB and Large Account segments grew by 7%. Quarterly sales in the Public Sector segment, which includes sales to government and education customers, increased by 21%.

Sales to state and local governments and education customers increased by 30%, whereas sales to the federal government were down 3%. Gross profit dollars for the Public Sector segment increased by 16%, and gross margin decreased from 10.8% to 10.4%.

The decrease in margin is attributable to the significant increase in sales of lower-margin notebooks and desktops during the quarter. Our consolidated SG&A expense increased by $4.2 million. However, SG&A, as a percentage of net sales, decreased by 28 basis points.

Variable SG&A accounted for a significant part of the increase in dollars due to higher net sales. Fixed SG&A expense increased due to planned additions to our sales teams and additions to our technical resources, including engineers focused on data center and cloud solutions.

In addition, SG&A expense in the third quarter included approximately 500,000 of depreciation related to our Customer Master Data Management project, which was put into service in Q4 2013. Overall, our financial performance was solid.

In addition to increasing EPS to $0.46 per share, we also increased our trailing 12 months adjusted EBITDA to $77 million. For the first 9 months of 2014, our results have been strong, with revenues up 11.5% and net income up 19%. Our balance sheet is also strong as our cash balance totaled $66 million as of September 30, 2014.

We regularly assess how to best deploy our excess cash in order 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. The overall IT market continues to undergo significant changes. In the last month, both HP and Symantec have announced plans to break into 2 companies, and Lenovo completed the acquisition of IBM's x86 server business. These industry dynamics may result in changes or reductions in certain partner-funding programs.

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 into Q4, we believe that sales growth will return to levels that are consistent with industry expectations.

We experienced substantial growth in the first 3 quarters from several areas that are not likely to continue to grow at the same rate in Q4, including the expiration of Windows XP and the increase in project rollouts.

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 lengthening -- or lengthening -- excuse me, purchasing decisions in some complex solution categories.

Industry experts have projected overall IT growth rate in the low- to mid-single digit range for 2014. Therefore, we believe that the current consensus estimates for the company's performance for Q4 2014 are reasonable.

Looking ahead to next year, our expectations for the first 9 months of 2012 (sic) [2015] are that our revenues will grow in the low single-digit range. Industry experts have reduced their growth projections and are now projecting overall growth in the 3% range and will be comparing against the 11.5% growth we've achieved thus far in 2014.

As a reminder, 2014 includes the increased activity from the Windows XP expiration, which is not expected to have any impact in 2015. In addition, IDC currently project a 7% decline in the education space for 2015.

Our SLED business is up almost 26% for the first 9 months of 2014, so it would be challenging to grow the business in 2015 given IDC's outlook for the education market. As changes in the markets continue to unfold, we feel it's critical that we manage our growth appropriately while 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'll now entertain your questions.

Operator?.

[Operator Instructions] Our first question comes from the line of Prab Gowrisankaran with Canaccord..

I have a couple of questions on the overall growth -- industry growth. You talked about maybe low to mid-single-digit growth. I know in -- for 2015, you said IT forecast is 3%.

Do you -- in your low single-digit revenue growth expectation, is it more -- are you expecting to accelerate the emerging technologies to kind of offset the expected slowdown in the rest of the areas? If you can add any color to that forecast that you provided..

Well, thank you. Clearly, we're making investments in advanced technologies. And we do expect that we'll have the opportunity to engage our customers in more meaningful data center conversations next year as we look at the expiration of Windows 2003. So I think, clearly, that will open up some opportunities.

So we are optimistic on some of the advanced technologies. But overall, I think the blended estimates that we're seeing from IDC, Gartner and from your industry peers are reasonable. So overall, I think they're pretty good..

Okay. And you do expect it even of this higher base like the first 3 quarters have been really high.

Do still expect a year-on-year low single-digit growth from this higher base in 2015?.

Yes, it'll probably be in the low-single digits, just given that we're comping against big numbers this year. We're up 11.5% for the first 9 months of this year. So it will be interesting growing next year, especially if the education vertical starts slowing down. That's been a real big winner for us this year..

Okay. The other question I have was in terms of your goal to expand advanced technologies.

Do you see that happening through organic growth or through acquisitions? And what are your thoughts on the use of cash that you have?.

Well, there are a couple of parts of the questions. So to begin with, we think we have a solid strategy and a right team in place, and we continue to make investments in the advanced technology arena. So we don't feel any pressure to do an acquisition.

But that said, we remain open should an acquisition come along that could be kind of a tuck-in, it would be accretive and that would expand us in one of our critical categories. So I think we're open to that. We are very conscious about our cash and we're always looking at alternatives [indiscernible]..

Yes. So in the last 3 years, we've done special dividends each year. We're always looking at acquisitions. We're looking at other possible uses of our cash. So we're evaluating everything right now. And no specific plans at this time to move in any specific direction, but we're looking at everything right now..

Our next question comes from the line of Jeff Martin with Roth Capital Partners..

Could you shed some light into the 7% decline that IDC projects in education? Is that because we're seeing a nice lift to 9 months this year? Is there something else behind that?.

Well, I think much of the drivers in the education space, many of them have already happened. I think the common core upgrades have -- are pretty much behind us.

And I think there is some tailwind we can expect to see from some of the E-rate changes, but overall, I think the high growth this year and the fact that many of the project upgrades have been done, I think that's really the main driver of their decline..

Okay.

And then, are you seeing any uplift in demand on the service side due to the Windows expiration or just still too early for that?.

I think it's an interesting question, and we've been looking at it closely. We're pretty confident that, that expiration is going to give us the opportunity to have really meaningful conversations with our customers about building the optimum data center for the future.

But we're also confident that that's going to open up a discussion in a number of areas, and it's much more complex than what we just went through with the Windows XP expiration. So we are watching that closely, but there's nothing that we've seen that would be significant in the quarter, and I wouldn't forecast anything significant for Q4..

And then on the advanced technology side, could you kind of give some perspective on where you're at today or where maybe you started the year and what kind of additions you're talking about in terms of capacity and what kind of learning curve there is for advanced technology personnel?.

Yes, so our internal goal is to have 50% of our revenue come from what we would consider to be advanced technologies. This year we've actually had a mix shift to notebooks and desktops because of Windows XP and some of these other factors. So we're sort of hovering around that 40% mix right now.

We're still doing very well with many of our advanced technology categories, especially software. And in terms of how do we grow that number, we really are looking to add people. I mean, that's really -- what we look to do to grow that number is to add more technical people to our headcount.

And those people are the ones that can have the complex conversations with our customers, get us more deeply into the data center. And so we're going to continue to hire those people..

And in addition, we also are very conscious of the infrastructure and the efficiencies required, so we are continually improving our own tools. We have a service management tool Web spot we've been investing in. We're continuing to make upgrades behind the scenes that will ultimately make the teams more efficient..

As you transition to 50% advanced technologies, what is the gross margin profile the business look like at that point?.

Yes. So really the advanced technology business is our higher margin. If you look at some of our competitors out there that are heavily advanced technology, you can see gross margins in the high teens or even the 20s, but we do have a big mix right now still of notebooks and things like that.

So I think you're going to see a gradual evolution in our gross margins over a number of years to tick up 10 basis points, 20 basis points a year as we continue to move in that direction, but we can get much higher than where we are today..

Okay, great. And then last question.

Any feel for market share gains? Although it may be gradual, how do you feel you're faring there?.

So we're pretty confident that we're taking market share. Right now, we think we're growing ahead of the market. It's pretty vast market. But the latest estimates that we've seen -- we think that the market in Q3 might have grown in our channel around 7%. And we know we're ahead of that.

And from what we've seen from some of our suppliers, we are confident that we're taking market share..

[Operator Instructions] Our next question comes from the line of Scott Tilghman with B. Riley..

Two areas that I wanted to focus on. First, just getting a little bit more color on the mix of business in third quarter.

What was better spending? What was some XP carryover? What was onetime, just to understand the strengths and the revenue number?.

Well, thanks, Scott. I'll kind of start. We had really strong growth in the quarter from software and with strong growth in servers and then, of course, very strong growth in the notebook category. I don't think much of that was about Windows XP. I think that tailwind really has expired. That was behind us.

I think we did see some pent-up demand for projects, and of course, we had terrific help from our Public Sector business, specifically, the state and local business. They had really strong growth in both notebooks and Chromebooks..

Yes. That's really the main factors of mix in the quarter. Notebooks, servers, software were the strong components of it..

Right. No, I was just trying to get my hands around what was potential carryover from XP versus what was new business not tied to that..

Yes. We saw almost 0 to be honest with you. A very insignificant number in Q3 from Windows XP is that -- for us, it seems to be concentrated in the first 6 months of this year..

The second thing I wanted to ask about is focus areas for investment. And you've touched on this a little bit with the question about acquisition. I was wondering if you could remind us what areas do you feel you're underserved or don't have the expertise that you would like to have, what areas are of interest that maybe you're not involved in at all.

And then related to that, how much of a pipeline of either personnel or small business tuck-in opportunities are you seeing?.

So if we gave you the impression that we're understaffed or underserved in what we will call our practice areas, I think we're actually pretty strong. We want to continue to invest. We've come a long way, and we'll got a long way to go. So it really is a journey. We are some changes out there in the competitive landscape.

Several new and disruptive technologies are coming into play. And so our challenge is to make sure that we're ahead of those changes, so we can advise and counsel our customer base as to what's best for them in solving their business problems with IT.

So an example, might be we're seeing lots of changes and lots of disruption in the storage space, and we're seeing a lot of companies who want to have discussions about moving workloads off premise. And so those are the examples for example that we would want to make sure we're continuing to invest in.

So when you net that out, it really is the converged data center. So that's networking, security, storage, server arena. In the software space, we've made big investments. We're showing great growth there. Software is growing is really well, and we're going to continue to grow there.

As we move into the future, more of the data center is going to be software-defined, so we'll continue to add resources there..

With the multitude of regional players, are you seeing any opportunity to take them out to acquire them or are they basically giving up market share as you and your large competitors grow?.

I think for the time being, we're focused on is taking market share. It's -- it hasn't quite made financial sense to pay a lot of money for a local guy or regional guy based on what people's expectations are currently. But right now, we're focused on taking market share.

We're certainly open to acquisitions, but we'd -- we really need to convince ourselves it's going to be accretive in year 1. So we're going to continue to take market share, and we're going to continue to look at acquiring, and maybe we'll do some of both..

I am showing no further questions on the phone line at this time. I'd like to turn the call back to Tim McGrath for closing remarks..

Well, thank you operator. We are encouraged with PC Connection's strong performance this quarter. We had solid execution against all 3 of our sales segments, reinforcing the strength and diversity of our business model.

As a national solution provider, our goal is to consistently invest in more complex solution capabilities while delivering solid financial performance. And we're able to accomplish that goal in Q3 with 10% increase and a 15% increase in sales and earnings in a rapidly changing industry.

We believe the teams and the strategies that we have in place position PC Connection well to gain market share and increase long-term shareholder value. And 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 those of you listening to our call this afternoon. Your time and interest in PC Connection are appreciated. Have a great evening..

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