Tim McGrath - President and CEO Joe Driscoll - CFO.

Prabhakar Gowrisankaran - Canaccord Genuity Inc Jeff Martin - ROTH Capital Partners Anthony Lebiedzinski - Sidoti & Company Adam Tindle - Raymond James Scott Tilghman - B. Riley & Co..

Good afternoon, ladies and gentlemen, and welcome to the First Quarter 2015 PC Connection, Inc Earnings Conference Call. My name is Jonathan, 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-session.

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 facts, may be deemed to be forward-looking statements.

Various remarks that management will 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 of any date subsequent to today. Today's call is being webcast, and will be available on PC Connection’s Web site. The earnings release is also available on the Web site. I’ll now turn the call over to Tim McGrath. Please proceed sir..

Thanks, Jonathan. Good afternoon, everyone, and thank you for joining us today to review the Company’s first quarter financial results. We are pleased with our first quarter performance. Net sales grew by 3.8%, led by sales growth of 16% in public sector business.

There was significant refresh activity in the prior year quarter due to the Windows XP expiration that did not repeat in the current year quarter. As expected, our higher margins categories had strong growth. This resulted in earnings growing faster than sales as net income increased by 20% as compared to the prior year quarter.

As we review our results, please note that unless otherwise stated, all the first quarter 2015 comparisons are being made against the first quarter of 2014. Consolidated net sales increased year-over-year by $21 million or 3.8% to $581 million. Gross profit dollars in the quarter increased by 7% to $78 million.

Consolidated gross margin increased 34 basis points to 13.35%. This was the result of a product mix shift to higher margin categories, including software and data center products. SG&A increased by $2.3 million in the quarter. Variable SG&A accounted for part of the increase due to the higher net sales and gross profit.

Fixed SG&A also increased due to planned additions to our sales teams and additions to our technical resources including engineers focused on data center and cloud solutions. We are also opening a new distribution center later this year which will significantly increase our capacity to handle advanced configurations.

There will be duplicate costs of approximately $1.2 million in 2015, as we transition out of the other DCs. This expense will be spread over the last three quarters of 2015. Net income for the quarter increased by 20% to $8.6 million and diluted earnings per share increased from $0.27 to $0.32.

We increased our earnings faster than the rate of sales growth by improving gross margins and leveraging our fixed costs over higher net sales. And now, I’ll turn the call over to Joe Driscoll, to discuss the results of our business and financial highlights.

Joe?.

Thanks, Tim. Sales for our SMB segment, which serves small to medium-sized businesses, increased by 1.4% to $250 million, with a double-digit percentage decrease in the desktop category, offset by increases in the storage, networking, and notebook categories.

The decrease in desktops is consistent with recent news releases from manufacturers and industry research firms. Gross profit dollars for SMB increased by 3% to $38.8 million, while gross margin increased by 68 basis points to 15.5%. The increase in gross margin was due to increased demand for higher margin categories such as storage and networking.

Sales by our Large Account segment increased by 4.2% to $209 million. We experienced double-digit percentage sales growth in servers, software, and storage. Total gross profit dollars grew by 4% and gross margin remained flat at 12%.

Our overall commercial sales, which is the combination of our SMB and Large Account segments, grew by 1.1% over the prior year quarter. Quarterly sales in the Public Sector segment which includes sales to government and education customers, increased by 16% to $122 million.

Sales to state and local governments and education customers, increased by 4%, whereas sales to the federal government were up 48%.Federal government sales represented 7% of our consolidated revenue in Q1. Gross profit dollars for the Public Sector segment increased by 24%, and gross margin increased from 10.5% to 11.2%.

The increase in margin is attributable to the significant increase in sales of higher margin, storage and servers during the quarter. Overall, our financial performance was solid. In addition to increasing EPS to $0.32 per share, we also increased our trailing 12 months adjusted EBITDA to $83 million.

During the first quarter, we generated $19 million of positive cash flow. The Q1 2015 cash balance of $80 million is higher than our 2014 year-end cash balance due to seasonally lower working capital requirements.

We regularly assess how to best deploy our excess cash and our goal is to maximize shareholder value while maintaining financial flexibility. I’ll now turn the call back over to Tim to discuss current market trends..

Thanks, Joe. As you may recall, in Q1 of 2014, we experienced significant growth in notebooks and PCs due to the expiration of Windows XP. This did not repeat in 2015. In Q1 of 2015, we increased sales in our more complex areas, especially software, storage, and servers, as we continue to focus on advanced solutions.

The change in mix drove a 34 basis point improvement in our gross margin, which led to solid bottom line performance. The overall IT market continues to undergo significant changes. Some of these market changes have resulted in reductions in certain partner funding programs.

In order to maximize channel incentives and our overall profitability, we need to continue to invest in emerging technologies that will increase our SG&A expenses.

Consistent with the outlook provided by many key players in the IT supply chain, we believe that 2015 will be a relatively low growth environment especially in desktop PCs and the related categories. In addition to the overall industry outlook, we are comparing against the very strong growth that we experienced in 2014.

Sales grew by 11% in fiscal 2014. Q2 of 2014 was particularly strong at 13.6% growth. The combination of the difficult market conditions in the large prior year comparison is expected to result in a challenging Q2 for us. In addition, current industry growth estimates for 2016 are consistent with 2015 in the low single-digit range.

We are highly focused on continuing to grow the bottom line faster than the top line. In order to accomplish this, we must continue to increase gross margins and control costs. The end of support for Windows Server 2003 represents an opportunity for PC Connection. Nonetheless, the impact of the opportunity will be smaller than the 2014 XP tailwind.

Today customers have many more options for data center solutions. The complexity of these options combined with the ongoing needs of customers to enhance their IT security gives us confidence that the services we provide will be even more relevant in the foreseeable future.

As changes in the market continue to unfold, we feel it's critical that we manage our growth appropriately with a focus on expanding margins, investing in solution capabilities, and 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. And now we’ll entertain your questions.

Jonathan?.

[Operator Instructions] Our first question comes from the line of Prabhakar Gowrisankaran from Canaccord. Your question please..

Thanks for taking my question and congrats on a strong quarter. The first question was related to the strength you saw in servers. Is the Windows 2003 Server upgrade happening earlier than XP? I know XP refresh was a little bit more towards the middle of the year, but you had a strong server quarter.

Is that mainly all driven by the 2003 refresh?.

Well, thanks. Actually there is a couple of forces we think driving that growth. One is, as you correctly mentioned, the XP refresh that happened last year was really in the first two and into the third quarter and the server refresh seem to come out of the gates fairly early and fairly strong.

But there are two drivers, it's not just the Windows expiration or Windows Server 2003 expiration, it's also the server cycle, the upgrade cycle depending on whose numbers you look at. It’s been at least three years.

And so since customers, I think focus last year on the desktop, notebook infrastructure, it's pretty logical now they are looking at the server and more data center product infrastructure..

Okay. And the other question I had was, you also mentioned you had lot of strength in storage.

Is that more the same customers once they upgrade the server and they are looking at the data center? They look like they start adding into storage, is it similar customer base or are you seeing storage strength in other places?.

So storage, we are seeing strength across all of three subsidiaries.

And as you know part of the -- sort of the power in the balanced portfolio is the subsidiaries are strong at different times, but the storage growth at about 23% was strong across pretty much across the board I think SMB and our public sector group both had some pretty strong performance numbers in the quarter.

Going forward for storage, we are optimistic. There are more choices available, more disruptive technologies available, but I think we’re looking at some of our markets that still have a long way to go as we go into our education buying season..

Okay. And the last question I had was on the software strength. It looks like fed, you benefited from software strength, and you also added some color on security and cloud offerings.

If you could explain or add a little bit more color on what those offerings are and who the users are?.

So in both categories, software and security, we were fairly strong across the board. Security software was particularly strong.

We had some real points of like as you might guess this is an environment where every customer wants to engage in a security discussion and depending on the level of that solution, there is usually a software component to that. And frankly, we are seeing that, so we are seeing good growth there.

We also had a good growth in our cloud offerings and our cloud offerings due range across the board. We have public cloud offerings where we work on a referral and on a commission basis and we also have many of our customers build out their own hybrid and private cloud strategies..

Great. Thanks for taking my question..

Thank you..

Thank you. Our next question comes from the line of Jeff Martin from ROTH Capital Partners. Your question please..

Thanks. Hi, Tim. Hi, Joe..

Hi, Jeff..

Hi, Jeff..

Could you go into a little more detail about the strength in the public sector, specifically federal? If there is anything specific driving that and if there is any leg to that demand cycle?.

Yes, federal for us in Q1 is really project based. So we had -- these were actually orders that would have come in sort of at the end of Q3, beginning of Q4 last year and because there is such large projects and large rollouts, they actually didn’t ship out the door till Q1 of this year.

So I think what you will see with federal is that you do get some lumpiness as large projects hit in a particular quarter. So we are very happy with the federal business in Q1. It was up by a large amount and it was in all the categories that we are really trying to focus on, some of the more advanced areas.

So I’m not sure you can necessarily draw a conclusion for the rest of the year that federal is going to be up 40% every quarter, but we certainly had an excellent Q1 there..

And we're fairly optimistic about federal in Q2. And of course the big federal buying season is Q3..

Okay. And then could you go into a little bit detail? You mentioned $12 million for the distribution center consolidation.

Can you talk about on the backend what some of the benefits and savings you expect to receive out of that?.

Sure. So as -- Jeff, as we probably talked about in the past, we were really seeing our customer base look at buying business outcomes and they really want and need our help delivering that end-to-end [technical difficulty].

And today we can do that very efficiently with our advanced configuration centers so that we can manage and pull together all facets and all components of that solution and deliver to the customer a turnkey outcome.

And as a result of that, new technologies are available, state-of-the-art technologies are available, and I think the ability to do that in a cost efficient way is really what we're driving after and we are pretty confident that about September of this year we will open the operation and we're pretty excited about what we see..

And just to add on to what Tim is saying, we are also moving from two distribution centers into one. So you pick up a tremendous amount of efficiencies just by having everything within one facility. So you are not transitioning product back and forth and things like that.

So we see some real positive things coming out of this and you would probably want to see that till 2016, but we're doing all the work in 2015 to get our self ready for the future..

Okay.

And then, could you give us an update on the expansion of your technical experts in emerging technologies? Anything you think that’s driving incremental sales for you?.

So what we’re -- we are continuing to add headcount and people in our advanced technology space. We have seen a good growth in security and in the converged data center, and we are seeing a lot more demand there.

We are also adding folks in our software area and that really has been a point of light and a great growth spot for us and we'll continue to invest in those areas.

But finally, when you think about the third platform, you think about what we're doing and what the market needs around mobility, what the market needs around big data security and cloud and those are all of the areas that we are investing in..

Okay.

Is there any quantifiable or are you seeing it internally in terms of the lift as a result of those efforts versus maybe what the broader industry growth is doing?.

So our internal goal is to try to get 50% of our total revenues to come from what we consider to be advanced solutions. And that's really why we are hiring these people as to try to drive those advanced areas. So we're not at that 50% mark yet, but Q1 of 2015 was significantly better than Q1 of ’14 in terms of that mix.

So we are moving in that direction and sort of quarter-by-quarter we are trying to continually move towards that 50% of our total sales. And the reason we're doing that is that's what our customers want and need and it’s also a higher margin business, if you’re selling into more advanced areas, you should be able to generate better margins..

Okay..

Jeff, we’re also seeing though a more disruptive technology. And we have to adapt, we have to innovate and we have to be able to help our customers solve their business issues with technology. So we will continue to drive investments into that area as needed..

Great. Thanks for your time..

Thanks, Jeff..

Thank you. Our next question comes from the line of Anthony Lebiedzinski from Sidoti & Company. Your question please..

Yes. Good afternoon. Thanks for taking my questions.

So first, just wondering if you could just comment on your performance on your four vertical markets that you have previously touched on in other conference calls as far as healthcare, financial, banking, energy, retail, if you could just give us some comments about that?.

Thanks, Anthony. So we don't break out the financials specifically by vertical, we breakout by subsidiary.

So the vertical markets across the subsidiary lines we did see in healthcare last year we had some very large projects and some rollouts and so we saw a little slowdown in healthcare, but we are optimistic with -- that telehealth and some of the other programs that we are driving, that we are going to see a good growth overall for the year.

For the other verticals, we see it as an opportunity. So I don't have specific numbers on retail, on financial, or on the energy market, but we are seeing good wins and we are clearly optimistic about where that market is moving..

Okay. Got it.

And what is your view of acquisitions nowadays? Are you still looking at potentially acquiring some other companies?.

Anthony, we -- in general, we believe that we’ve got a very solid strategy. We think we have wrapped a solid plan round that. We think we have terrific people to go execute our plan. So we don't feel a pressure to do an acquisition right away.

However, we clearly would be interested if we found the right tuck-in acquisition that had I think a comparable culture and one that would be accretive; we are always on the lookout for opportunities like that. But it really would have to deliver a higher value add solution or solve a market niche for us..

Got it. And on your January 30 conference call, you talk about your expectation for 2015 EPS to be up mid-single digits before the distribution center related costs.

So in light of the strong performance in the first quarter, what is your expected view now for 2015 EPS?.

Yes, I think we definitely outperformed in Q1. I'm not sure that necessarily carries forward to outperformance in every quarter for the rest of the year. So the estimates I have seen out there for the rest of the year seem fairly reasonable to me. I think Q2 is going to be our biggest challenge just because of the big comparisons from prior year.

But long-term, we feel very good about our strategy and our plan and where we're going. Unlike I said, Q2 might be more challenging than the other quarters, but I would necessarily change anybody's estimates for the balance of the year..

Okay. All right. Thank you very much..

Thank you..

Thank you. Our next question comes from the line of Brian Alexander from Raymond James. Your question please..

Thanks, guys. This is Adam Tindle in for Brian. Just wanted to ask Tim to give us a little bit more color, you had mentioned SG&A increasing due to vendor incentive changes.

Can you talk about those vendor incentive changes, and give us little color there please?.

Well, thanks Adam. I’m going to let Joe cover that. I think there were -- I was trying to convey there were probably a number of drivers that make up the SG&A component. But I will let Joe net it up..

All we are saying with the vendor incentives is that the vendors are changing their programs fairly frequently every quarter for example. Really what they want us to be able to do is sell their latest technology. That's where you get the most vendor incentive dollars.

And in order to sell those technologies we need to have the experienced technical people on our staff in order to generate those kinds of sales. So what we are talking about is that we need to keep hiring technical people in short to -- in order to stay ahead of the curve in terms of where the vendor funding is going..

Okay. Thanks guys. And I guess, last question, can you remind us a little bit more on capital allocation priorities based on the clean balance sheet, accelerating cash flows.

I know you mentioned a little bit on M&A, but can you kind of rank a little bit more on your capital allocation priorities please?.

Yes, so where does our capital go? First thing that we are doing is really investing internally in our business to make sure that we are strong from an infrastructure perspective. So we are investing in computer systems, we're investing in a new distribution center this year, various things like that to really make sure our business is strong.

From that point, then you are looking at other acquisition opportunities out there, that is certainly something that we are interested in looking at. If there is no acquisitions that are pending or imminent, then we will look at other means of capital allocation. Last four years we’ve done a special dividend.

Each of the last four years we have done some share buybacks in the past. I guess, we would say we continue to look at all those options to try to maximize shareholder value..

Did that answer your question?.

Yes, thank you..

Thank you. Our next question comes from the line of Scott Tilghman from B. Riley..

Good afternoon..

Good afternoon, Scott..

Most of my questions have been answered, but there were really two that I want to follow up on. One, a clarification around your comments on the challenging to 2Q. I mean, clearly we can all see the type of growth that you experienced a year-ago.

Directionally, however, are you looking for this year to be down versus a year-ago or still you modestly positive?.

It's a great question, I mean; I would say right now the best assessment we can make right now is we are going up against big comps from last year. So I would say we are going to be right around last year’s numbers, it's probably the best estimate right now. But there is still several months to go in the quarter, those numbers can obviously swing.

But our best guess right now is it will probably be somewhere around where we were last year in Q2..

And related to that, you talked earlier about some of the fed growth being project based with the shipments occurring recently.

Are any of those carrying over into 2Q?.

I think overall we are fairly optimistic about the federal demand environment and more than that is winning our fair share of those federal projects.

Now Scott, as we enter our 34th year of business here -- or we are into our 34th year, we’ve got a really strong team, we’ve got a lot of loyal customers, and in the federal space there is still a lot of projects and contract vehicles. And so we feel like we are going to win our fair share of probably more than our fair share in that space.

It might not be the very large numbers that we saw last year. Clearly, we are going to see growth in fed. But again as I think Joe mentioned, to put it in perspective, Q2 last year if we look at company-wide notebook growth, it was about 30%.

If we look at company-wide last year, our desktop growth that was about 14%, and so those are big compares when you think about that component of the business. While we are expecting some notebook growth, the desktops have really slowed down as was predicted and planned with the Windows XP expiration.

So as we shift into these data center categories, we are optimistic. And we are winning in those categories, but that is still a smaller share -- kind of a lesser tailwind than we saw from XP..

One follow-up tied to that and then I have a final question. With the changes in vendor funding, the push towards newer technologies and as you pointed out the strong growth in a few categories last year.

Are there any risks to margin because of lost partner incentives in 2Q being up against that big compare or you should -- will the mix shift this year and the changing incentives offset one another?.

Yes, I think what you will see is some vendors will be higher and some vendors will be lower as kind of what happens every quarter to be honest with you. We might be getting fewer dollars from some of the sort of the volume vendors, but hopefully that would be made up by higher dollars from some of the more advanced technology vendors.

So we're not -- as we said here right now, we are not projecting any kind of steep decline in Q2 overall..

That's helpful. And then the last question. You talked about the industry forecasts for low to mid single-digit growth this year and next year. Looking at domestic numbers, I have seen a few that factor in global and obviously currency gets in the way.

With that framework and looking at what you're seeing into the fragmented nature of the business as a whole, has the competitive environment changed significantly over the last few quarters or are you still sort of seeing the same faces when you are bidding for business or even seeing some fade away?.

That's a good question, Scott. So I think what we're seeing is for some opportunities we are seeing -- that require a high degree of specialization. Security, storage, we are seeing some local VARs and niche players, but based on our model, our scope, our scale as a national solution provider, we’ve done quite well against them.

We believe we are taking market share and so by and large I would say the faces really haven’t changed. There is not a -- there is probably the threat of some new entrants in software, but we’re really not seeing that..

Great. Thank you..

Thank you..

Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program back to Tim McGrath for any further remarks. End of Q&A.

Well, thank you Jonathan. We are pleased with our performance for the quarter. An increase in demand for higher margin data center products was the key contributor to our 20% growth in net income. In addition, good working capital management created positive cash flow of $19 million in the quarter.

We believe our team and the strategies we’ve in place, position us well to gain market share and increase long-term shareholder value. And I would like to thank all of our customers, vendor partners, and shareholders for their continued support and our dedicated co-workers for their efforts.

I'd also like to thank all of you listening to the call this afternoon your time and interest in PC Connection are appreciated. Have a great evening..

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..