PC Connection Inc (CNXN) 2002 Q1 法說會逐字稿

Good morning and welcome to the PC Connection first quarter 2002 earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions and comments following the presentation. I would now like to hand the floor over to your host, Mark Gavin. Sir, the floor is yours.

Thank you very much. Good morning everyone and thank you for joining us today for PC Connection’s first quarter conference call. If you’ve not already received our press release, you may contact [_______________] at 603-423-2322 and our release will be faxed or emailed to you immediately. You may also view the release on our website. Today’s call is also being web cast. It is available on the PC Connection website and on streetevents.com. Before I turn the call over to Pat Gallup, Chairman of PC Connection, I would like to warn all participants that these statements or references made during the conference call are not statements of historical fact maybe deemed to be forward-looking statements. There are a number of important factors that could cause actual events or the company’s actual results to differ materially from those indicated by such statements. These factors include but are limited to those identified under the captions “Factors That May Effect Future Results and Financial Condition” in the Company’s Annual Report on Form 10-K dated December 31st, 2001, which is on file with the Securities & Exchange Commission, and now I’ll turn the call over to Pat Gallup, Chairman of PC Connection.

Good morning everyone. Thank you for joining us. Also here in the call with me and Mark are Ken Koppel, CEO; Wayne Wilson, President; and Bob Wilkins, Executive Vice President. We’re pleased that our sales to commercial and consumer customers appear to have stabilized sequentially in the first quarter despite poor overall results which will cause us to report our first quarterly loss since becoming a public company. Overall, demand for information technology products continues to be sluggish. Our near-term strategies remain focused on improving the productivity of our commercial business, achieving results from recent investments in our government and education business, and supporting the continuing sales success of our recently acquired subsidiary MoreDirect. At this point, I’ll turn the call over to Ken Koppel who will give you more detail on these three initiatives as well as review the quarter’s highlight. Ken?

Thanks Pat and good morning to those listening. I will review with you some of the highlights of the first quarter as well as progress on some of our initiatives to restore growth to our business. Then Wayne will give you an overview on some of our quarter’s key performance matrix and update you on our outlook for 2002. Our results for Q1 were disappointing. Net sales for the quarter were 236 million down about 13% from Q4 and 22% from Q1 of 2001. Losses were 8 cents per share compared to earnings of 10 cents per share in Q1 2001. Sales in all product categories continue to be negatively effected by the lackluster spending for information technology products with sales of notebook computer systems continuing to decline by a significant percentage on a year-over-year basis. Average order size declined about 16% sequentially to levels not experienced since 1999, and average selling prices or ASPs continue to decline sequentially as well as year over year. Sales to government and educational organizations grew approximately 5% year over year during the quarter. Sales for the federal government were flat year over year but down approximately 34 million sequentially from a very strong 2001 fourth quarter. As I noted in our press release, we remain optimistic that our federal government business will have another strong year in 2002. We continue to make substantial investments in our government and education business including additional field, new telesales personnel, specialized sales training programs, focus marketing materials, and enhanced website capabilities. Declining sales volumes and increasingly cost conscious customers continue to put pressure on pricing and product gross margins. For the first quarter, our gross margin 0.6% compared to 10.9% in Q4 and 11.7% in the corresponding period a year ago. We are intensifying our efforts to improve our product margins over the balance of 2002 through the following: Enhancement demand on sales for accessories and consumables, increasing sales of enterprise class products as a percent of total sales, increasing accounts penetration with PC Connection and third party value-added service offerings, and overall a greater focus on solution sales. In Q1, net sales of enterprise products were 21% of total net sales down from 23% in Q4. The rate of decline in the sales of enterprise products continues to be lower than the rate of decline in the sales of desktop products. As we accelerate this shift in our marketing emphasis from the desktop to the enterprise and the network, we have added additional resources to our enterprise product and value-added services programs and expect to be doing so throughout 2002. Our outbound sales managed account program accounted for 76% of net sales in Q1. We closed the quarter with a total of 468 account managers compared to 464 at December 31st, 2001. During Q1, consistent with our ongoing assessment of business condition, we paced our sales recruiting to focus our resources on recruiting experienced account managers and increasing the success rates of our existing account managers. We believe this strategy is working, and we expect to continue in this manner in coming quarters. Accordingly, the total number of account managers may increase or decline slightly in Q2. We will continue to hire new account managers selectively consistent with our quality standard and subject to our continuing evaluation of business conditions. So how are we doing in our efforts to restore growth to our business? We continue to focus on several objectives which are central to our strategy. One, to maintain and enhance our financial stability. Two, to sharpen our sales and marketing execution in light of current economic conditions. Three, to aggressively analyze all of our operations to reduce our operating costs while finding or redeploying the resources necessary to continue investing in the sales, marketing, and technology programs needed to ensure our future growth and prosperity. And four, in addition to these continuing objectives, we remain open to market opportunities such as our recent acquisition of MoreDirect. First, as always, our financial position remains very strong. Wayne will speak to you about our balance sheet in a moment. Second, I continue to devote most of my time to our sales and marketing activities, especially sales management development and the deployment of marketing programs to support our sales initiatives. With respect to our sales organization, several programs or changes in programs were carried out in the first quarter including implementation of the consolidation of our government and education businesses into our new GovConnection organization, continuing recruitment or promotion of additional high talent sales managers, and the addition of management resources to our enterprise solutions sale teams and the organization of our sale teams into geographic territories with a focus on new account acquisition. We believe that these and other planned initiatives are beginning to improve the productivity of our account managers and that such improvements will become visible over the next several quarters. Our goal is to improve our net sales per account manager by 50% over the next 12 to 24 months. On the marketing front, our current programs and activities continue to be reviewed and modified to improve their alignment with our sales strategies. During the first quarter, our marketing and merchandizing organizations, one, commenced the rebranding of our government and education businesses as GovConnection. Two, deploy the first release of the customer and prospect marketing database. Three, generated significant quantities of new collateral marketing material. And four, launched new promotional viables. We’ve also revamped plans for our catalogue marketing programs to sharpen their focus. Our previously announced investments in our website marketing capabilities and infrastructure are continuing on schedule. We expect to launch our new web service in the second quarter as planned. We are also continuing to invest in our information systems infrastructure to improve the quality and timeliness of customer and product information provided to our sales organization. Third, reducing our operating costs continues to be a high priority. We’ve made numerous staffing adjustments and continue to scrutinize all areas of our operations. We expect to see increasing progress in our profit improvement efforts in the coming quarters. Finally, we continue to look for opportunities in the consolidating market. Our recently consummated acquisition of MoreDirect is consistent with our long-standing strategy of seeking to acquire businesses with similar corporate cultures which add new customers and management tala and are immediately accretive to our earnings and key operating rate shifts. Russel Madris, founder of MoreDirect and his management team have built a very successful organization that services medium to large corporate and government customers to leveraging a high quality sales organization with an internet based e-procurement solution. MoreDirect system enables corporate and government customers to efficiently source, evaluate, purchase, and track a wide variety of IT products. We believe the system is very scalable. We also believe MoreDirect’s customers will benefit from PC Connections wide range of service offerings including overnight custom configuration as well our additional inventory and logistics capabilities. In summary, we continue to believe that our telesales based and technology enabled rapid response delivery model will be the winner in serving the information technology needs of business and government and education organizations. We continue to balance the need to continuously upgrade our capabilities to ensure long-term customer satisfaction and shareholder value within the restraints imposed by a weak market. And now Wayne will provide you with some further details about our financial position and operating matrix. Wayne?

Thanks Ken and good morning everyone. First, I will review with you some of our key matrix and then talk about some of the trends and other factors affecting results. Starting with the income statement, average order size declined as Ken noted about 16% sequentially to $894 in the first quarter from $1061 in the fourth quarter of last year and decrease about 14% from $1040 in Q1 of 2001. Average order sizes have been declining gradually for several quarters in the commercial business, as large orders generally thought of as greater than $10,000 declined in volume. This trend was substantially offset by seasonally large average order sizes in the federal business during the third and fourth quarters of 2001. The sequential decline in the first quarter resulted largely from the seasonal decline in average order size with the federal business. The number of orders rendered for the quarter actually increased to about 5.5% compared to the fourth quarter of 2001 and declined about 11% year over year compared to the 22% decline in net sales dollars. Average selling prices or ASPs for computer systems decreased during the quarter by about 6% compared to the fourth quarter of last year and were down approximately 21% year over year. These trends are similar to those reported for the last several quarters. We continue to see downward pressure in the first quarter pricing environment as well as a continuing lack of significant new product models which would tend to reset ASPs, especially for notebooks. ASPs for servers were down 6% sequentially while declining only 1% year over year. Pricing in the server market continues to be very competitive with first quarter unit volumes declining about 14% sequentially. On the positive side, we are currently seeing increasing opportunities to code combined net server and data storage solutions, and we will be focusing more of our efforts on the marketing of solutions sets to customers as opposed to the individual components. Desktop computer ASPs were down 11% this quarter and notebook ASPs decreased about 21% on a year-over-year basis. Sequentially, desktop ASPs were down 7% while notebook ASPs actually rose about 6% over the fourth quarter. While notebook unit and net sales volumes were down sequentially by 39% and 36% respectively, desktop revenues rose 13% sequentially on a 21% sequential increase in unit volumes, despite a sequential decline in desktop average selling prices to $914 in the first quarter from $982 in the fourth quarter of last year. At these prices points, we are beginning to see some customer preference for replacing notebooks with desktops in corporate upgrade situations. We continue our focus of sales of enterprise class server networking products. Sales of these products declined about 19% in the first quarter of 2002 compared to the fourth quarter of last year and about 15% year over year. Looking forward, we have recently organized a new networking solutions team to extend our sales and marketing region to the enterprise class products category. Steps taken include, as Ken mentioned, recruiting new management leadership. In addition, we are grouping certain product marketing, and technical and sales and service teams together to sharpen our focus on the enterprise solutions and developing new sales and marketing vehicles to more effectively target solution sales opportunities among our customers. Selling, general, and administrative costs or SG&A came in for the quarter at 11.6% of net sales compared to 10% in the fourth quarter of last year and 10.1% a year ago primarily due to lower sales volumes. The actual dollar amount of SG&A declined about 10% in the first quarter on year-over-year basis and was virtually flat compared to fourth quarter of last year. Sequential declines in personnel and other regular operating expenses were partially offset by a significant increase in website related costs. All spending plans and programs are under continuous review to ensure the best possible deployment of our total resources. Moving to the balance sheet, cash was very strong at quarter end at $42 million. As noted in our press release, cash payments made in connection with our acquisition of MoreDirect was funded from cash balances without the use of any borrowed funds. Accounts receivable were down 19 million to 99 million at March 31 from a 117 million at last December 31. Day sales outstanding or DSOs were 58 days compared to 56 days in Q4 and 50 days in Q1 of a year ago. Day sales outstanding for federal government customers continues to lag those of commercial customers due to strong sales in the federal sector in the fourth quarter and some continuing delays to the processing of payments by federal agencies. Excluding federal government sales, DSOs in Q1 were 47 days compared to 45 days last quarter and 47 days in the first quarter a year ago. Allowances for customer bad debts increased by about $69,000 from the levels recorded in the end of the fourth quarter. Such allowances now stand at 6.1% of customer accounts receivable versus 5.2% at the end of the fourth quarter. Inventory balances decreased by 11 million or 23% to approximately $37 million at March 31, compared to approximately $48 million last December 31, and were down over $28 million on a year-over-year basis. Net sales of products dropped shift by distributors and other vendors directly to customers accounted for 18% of total net sales in the first quarter compared to 29% of total net sales in the fourth quarter and 15% in the first quarter a year ago. Inventory turns were 19 compared to 21 in the fourth quarter. Based on quarterly end inventory levels, inventory days or as day sales in inventory were 16 at March 31 versus 18 at the end of December. Inventories are in excellent condition both in quantity and in quality. In summary, the balance sheet remains in excellent condition. Looking forward, our outlook for 2002 remains very cautious. Our first quarter results suggested sales to commercial and consumer customer segments may be stabilizing as noted earlier. With seasonably better quarters expected for our GovConnection business and the addition of MoreDirect, we expect that the company will see improved results of the remaining 3 quarters of 2002. For the second quarter of 2002, we presently expect to achieve sales in the range of $290 million to $310 million, and are currently projecting our earnings per share in the range of 3 cents to 5 cents per share. Although we are working aggressively to improve gross margins, we are not presently expecting an appreciable improvement in the gross margin rate for the second quarter. We are also not presently providing any guidance for the third and fourth quarters of 2002 beyond the general comments made earlier. As we have said in previous conference calls, we are working hard to ensure the best possible near-term results consistent with maintaining a strong financial position and investing for the future. Thank you for joining us this morning, and we will now entertain your questions. Operator?

Thank you. The floor is now open for questions. If you do have a question or a comment, you may press ‘1’ followed by ‘4’ on your touch-tone phone at this time. If at any point your question is answered, you may remove yourself from the queue by pressing the ‘#’key. Questions will be taken in the order they are received. We do ask that while posing your question that you please pickup your handset to provide optimum sound quality. Once again, it’s ‘1’ followed by ‘4’ on your touch-tone phone to ask questions. Our first question is coming from David Manthey of Robert W. Baird.

Hi, good morning everyone.

Good morning David.

I was just wondering if you could speak to the strength in the government business in the third and fourth quarter and the potential that what we saw there was an additional stimulus that the government wanted to inject in the economy that may be the strength that we saw in that period of time might not be indicative of what we might see in the second half of this year, can you comment on that?

David this is Wayne Wilson. I think the third quarter was truly a very strong quarter and was consistent with our patterns in the past. We did see some uptake in business in the last couple of weeks of September as we noted before, but certainly the third quarter was an out portion with growth we have seen in third quarters in the past. On the other hand, as we have said before and on our last call, our results in the fourth quarter were well above the normal trends that we would have expected to see, and that we did comment on our call last quarter that we did not expect that to continue in the first quarter. So the answer to your question is, Q3 was a very good quarter. We expect that to be part of our continuing pattern. Q4 was an unusual quarter. It did appear to have additional spending as a result of September 11 and government stimulus and do believe that periods results are above the normal trend line we would expect to see.

Okay, and could you remind us what the margin or the gross margin dynamics particularly of MoreDirect?

David this is Mark. Gross margins probably will be in the 10.7 to 10.9 range.

Okay, so right now no appreciable difference, but relative to where your core business could go historically those would be lower?

That’s correct.

Okay. Are those relatively constant over history for MoreDirect?

Yes it is, over the last couple of years those were very consistent marginally.

Okay.

That’s correct.

Okay, and then just one final question, when you say that you hope to see improved results in the remaining three quarters in the year, not to press you to elaborate on that, but are you talking about sequential improvements or are you talking about year-over-year improvements through out the year?

There would also be year-over-year improvements but we are also speaking to sequential improvements particularly from Q3 to Q2. If you just look at the historical patterns over the last couple of years, Q3 is typically a very strong quarter compared to Q2, and we also expect Q4 is also a very good quarter; those are two strongest quarters of the year.

David, it’s [_______________] for sequential and year over year, we would hope to see improvement results over the next certainly the second half of the year.

Okay. Fair enough. Thank you.

Welcome.

Once again, if you do have a question or a comment, you may press “1” followed by “4” on your touch-tone phone at this time. Our next question is coming from Brian Alexander of Raymond James, please state your question or comments.

Yeah, just a follow up on David’s question on the government side, I guess it was what about 40% sequentially or thereabout. You know last night CDW in their public business, and I don’t if it’s all apples to apples, it was down about 10%, so sequentially. I am just trying to reconcile the difference there, what might be different about your business mix versus theirs to the best of your knowledge?

This is Wayne, Brian. I think as we look at our federal business historically, our federal business has been much more of a high-end business, it’s been solution oriented. We historically had a much higher concentration of server networking infrastructure types of products. There was significant spending for those types of products in the fourth quarter. The first quarter has historically always been soft with respect to those sales because much of the sales that we record in the fourth quarter are as a result of purchase orders released by the government in the third quarter. As you come in to the first quarter, you are really waiting for new budgetary money. So much of our spending is may be notch or two up. The chain in terms of product set, average order sizes are certainly much higher in that business than they are in our commercial business, so as a result that business tends to be a little bit lumpier, but it is still very quality business and it directs where we want to take much of the rest of the business.

Thanks. On the gross margin line, could you just let us know what had more of an impact on the decline, was it more rebates, competitive pressures, and how did product and customer mix shifts help or hurt you in the quarter?

Really the most significant difference between Q1 and Q4 will be volume rebates Brian.

And do you expect sequentially they are going to take another step-down from here or come back up or...

I do not expect another step-down from here. You might see sequential improvement in the volume rebate in the Q2 versus Q1.

Any specific product areas or vendors that you could point to in terms of what ...

I think it is pretty much across the board when you go looking at all the different programs.

Clearly the largest numbers for those rebates come from the systems manufacturers and from the major corporate software players like Microsoft and clearly those are categories and certainly in the systems area that warranted strongly in Q1 and had a direct impact on the top line, so we think with some stabilization of the revenue line moving up on volumes in the GovConnection business, if their season went stronger therefore our volumes will be higher and if our volumes are higher we will achieve better volume rebates, although it should have some upward direction in the overall margin mix.

And then on MoreDirect can you just walk us through what your assumptions are in sort of revenue on margin contribution for the June quarter? Just to get a sense on what you are expecting organically.

Yeah, I would say revenue Brian would probably be in the $40 million to $45 million range, margins would be in the 10.7% range, and their operating margins would be in the 4% to 4.5% range.

Any major seasonality in their business that’s different than yours?

No I think their business is pretty consistent with our core commercial business. It’s not only the federal government business.

And the last question, any update on share repurchases this quarter?

We don’t anticipate that I’ll be buying back stock this quarter at this stage just because we used a lot of cash for the acquisition of MoreDirect.

Great. Thanks a lot.

Our next question is coming from Colin Campbell of Brookside.

Hi! A couple of questions. First, could you go over the changes in ASPs and revenue and units for desktops and notebooks sequentially year over year? I have got some of those numbers, but I think I missed some of the others.

Okay. Just give me one second. Notebooks this is consolidated results, so Notebook year-over-year results in units were down 33%, revenues down 48%. On a sequential basis, units were down 39% and revenues were down 36%. There was an uptake in ASPs in the first quarter sequentially the last 6%. We calculate average selling price based on the prices of the units we actually sell as opposed to the market basket. On the desktops, we had a very strong movement in the units, units were 2% up positive year over year and 21% sequentially. The primary manufacturers in that they were up very strong in the first quarter were Hewlett Packard and Apple, both lines were strong with demand. In the net sales line year-over-year revenue was down 9%, but it was up 13% sequentially. Average selling prices year over year were down 11% and down about 7% sequentially. ASP for desktops was $914 in the quarter versus $982 in the fourth quarter of last year.

Okay. And with regard to your comment on your expectation that vendor rebates will increase sequentially in Q2. Is there a typical seasonality of vendor rebates that we should be thinking about?

Historically, no, there has not been any appreciable seasonality. It’s really a function of what products are moving and if the product mix is stable quarter to quarter then typically there is not any real seasonality in that.

What is it that gives you visibility into the sequential increase in rebates in Q2 about?

It’s really looking at the target versus the volume pickup we expect in Q2 versus Q1.

Okay, so it’s more just volume thresholds.

It’s all volume thresholds.

Okay. And then another question on the comment that pricing is aggressive in the server market, can you remind us in what segments of the server market you guys play, and any commentary on which vendors are driving that aggressiveness on pricing? Thanks.

The server segment that we play in are clearly Wintel. We’re not currently in the Unix segment. We sell Wintel servers from the entry level, workroom server, all the way up to [_______________] some 8-way processors, most of the units will probably in the 2 or 4 wave kind of or 4 processor units, kind of where they are clustered today. This is a competitive price area and in any case the average selling price for those units in their first quarter was $2895 that’s down just a little bit from the fourth quarter, but they’ve been running in the $2500 to $3000 range. Competition is intense across other direct marketers in our space as well as Dell. Our strongest line has been and continues to be Compaq, although we do sell significant quantities or both Hewlett Packard and IBM servers.

Great. Thanks very much.

You’re welcome.

Next we have a followup question from David Manthey of Robert W. Baird.

Yeah, hi! A couple of follow-ups here. First of all, when you say that the sales to your consumer and commercial business was stable, not to talk too much about CDW here, but they’ve reduced their guidance then they reported a higher number than the guidance level that they had indicated and the reason for that was that the business accelerated into the back half of the first quarter in the last couple of weeks, and I am just wondering given your experience that you sort of hit the low end here, did you not get follow through in the first quarter in the first quarter as they did or am I misreading that?

When you look at the numbers what happens in regard to our previous guidance we gave, it was really more the federal government sales being delayed in Q1 into Q2, which really changed us being at the low end of the range. At that time I expected to be at the higher end of the range but a few orders were delayed into Q2. The commercial business pretty much came in online with what I was expecting at that time.

Technically the last 2 weeks of any quarter are usually the best 2 weeks of the quarter and we did see that.

You did?

Yes we did. We cut it strong.

Okay.

Just to clarify too, when we talk about commercial and consumer together we don’t break out with those numbers detail, but historically a small amount of consumer businesses is always lower in the first quarter than the fourth quarter and even though the combination was down a couple of million dollars, sequentially, as we noted in our press release, when we just look at the pure commercial business, it was actually up about $3 million or $4 million. So, the delta down was just the normal seasonal down on the consumer, but the core commercial business did strengthen a bit after having stabilized in Q4 over Q3. So, now having two quarters of stability and slight uptakes, not large, but slight uptakes, we believe with everything in that core segment.

Okay. And you mentioned website costs being up significantly this quarter, can you give us an idea of the magnitude of that and what was that for?

We were doing a number of things though some amount of the cost, the $200,000 were a part of the cost related to our next generation website. We also had some significant cost expended on promotional and marketing programs looking to attract new customers and approve traffic patterns. So, it’s generally those two categories.

Okay and that might be a good [_______________] going to the last question. I think it was Ken who was talking about some of the initiatives, talking about rebranding, something about working a new database, collateral marketing, which I don’t understand and new promotional marketing materials. Could you possibly just touch on each of those and explain what each of those are?

Yes. The database activity is intended to do two things. One, to identify a prospects, to engage our sales force in more active and aggressive prospecting than we have had in the past and also to help us better goal our sales people with respect to the potential of accounts. We reorganized the sales staff into geographic territories in large measure make the organization more accountable for their results on a geographic basis. The promotional initiatives, and there are several, which included the launching of, for example, an e?mail newsletter in conjunction with the Gartner Group are intended to let the IT professional community know that we have a full range of IT products and services, since we have been increasing the number of services, for example, and that is not well known in the customer community. So we are branding ourselves much more heavily than in the past as a full spectrum IT provider using a variety of media to do so.

Okay. I guess I understand the rebranding of the Gov ad, but what is collateral marketing? Is that what you are referring to there?

Yes. That is collateral materials basically everything from conventional mailers is part of new accounts development programs, to e-mail programs, to one of our activities, for example is a [_______________], which we do an event where we bring customers together, in this case with Compaq, so just a much larger number of activities to put our name and our capabilities, and our people in front of customers and prospects.

Okay. Great. Thank you very much.

I am sure no further questions at this time, I would like to hand the floor back to our speakers for any closing comments they may have.

This is Pat Gallup, I would just like to thank everyone for their time and for your questions, and have a good day.

Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time and have a wonderful day.