PC Connection Inc (CNXN) 2002 Q4 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the PC Connection Fourth Quarter Teleconference. At this time all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Mark Gavin. Sir the floor is yours.

Thank you and good morning everyone. This is Mark Gavin, the CFO. We are pleased to have you join us today for PC Connection's Fourth Quarter Conference Call. If you have already not seen our press release, you may contact [Arleen Gagnon] at 603-423-2322 and she will fax or email a copy to you immediately. You may also view it on our website. Today's call is also being webcast and that will be available on the PC Connection and on streetevents.com.

Before I turn the call over to Pat Gallup, Chairman and CEO of PC Connection, I would like to inform all participants that any statements or references made during the conference call and in our statements or historical facts may be deemed to be forward-looking statements. There are number of important factors that could cause the Company's actual events or results to differ materially from those indicated by such statements. These factors include, but are not limited to, those identified under the caption "Factors That May Affect Future Results and Financial Condition" in the Company's Annual Report on Form 10-K A filed on December 31, 2001, which is on file with the SEC. And now I'll turn the call over to Pat Gallup, Chairman and CEO of PC Connection

Good morning and again thank you for joining us. Also here with me on the call in addition to Mark Gavin are Ken Koppel, President and Bob Wilkins, Executive Vice-President.

As expressed in our press release, our fourth quarter results were stronger than we expected given the current economic environment. For the three months ended December 31, 2002, net sales increased by $48.6m or 18% to $322.2m from $273.6m for the three months ended December 31, 2001. Net sales for the fourth quarter included MoreDirect, a company we acquired in April 2002. The guidance that we provided to the investment community in October, 2002 was in the range of $315-325m. The consensus for net sales from the analyst community was $321m. Net income for the quarter was $2.9m or 12 cents per share compared to $1.4m or 6 cents per share for the three months ended December 31, 2001 -- a significant increase. The earnings per share guidance that we provided to the investment community in October, 2002 was in the range of 6-9 cents per share. The consensus for earnings per share from the analyst community was 7 cents per share. The difference between expectations and actual results is due to the achievement of higher gross margins and lower selling, general and administrative--SG&A expenses.

Excluding MoreDirect, our most recent acquisition, net sales for the quarter were $252m compared to $273.6m for the three months ended December 31, 2001. Earnings per share for the quarter, excluding the MoreDirect operation, were 2 cents per share compared to 6 cents per share for the same period a year ago. MoreDirect sales for the fourth quarter was $69.9m, flat with the third quarter but up 38% on a pro forma basis from the prior year fourth quarter. MoreDirect was acquired by PC Connection Inc. in April 2002.

In the market place, we continue to see encouraging signs that many of our customers are cautiously and selectively resuming spending for the Information Technology products, though certainly not at the levels of 2 or 3 years ago. With our focus on factors that we control, we believe that we can and will continue to improve our financial performance over the coming quarters.

We continue to be focused on several key objectives, which we have reiterated frequently in recent quarters. They are--to maintain and enhance our financial stability, to significantly improve the productivity of our sales organization, to reduce our operating costs, to increase gross margin, to invest for future growth and prosperity, and finally to remain alert for additional market consolidation opportunities. Our financial position remains very strong as Mark will highlight in a moment. Sales productivity on our SMB is improving. Over the past year sales productivity for the SMB segment increased on an annualized basis by 12.6% from $1.75m in the fourth quarter of 2001 to $1.97m in the fourth quarter of 2002. Average sales account tenure in our SMB segment increased over the past year from 21 months to 25 months.

We believe higher sales productivity is the key to leveraging our expense structure and driving future profitability improvements. Our gross margins for the fourth quarter of 2002 improved to 11.1% compared to 10.9% for both the third quarter of 2002 and the fourth quarter of 2001. On the costs side, we continue to adjust staffing and spending levels in all areas of our operations. Finally, we remain alert for opportunities and a consolidating market but we will only consider acquiring businesses with similar corporate cultures, which add new customers and management talent and are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter the Company grew sales and earnings, improved both gross profit margin and operating margins, and made progress in our efforts to enhance the productivity of our sales organizations. Our positive finish in 2002 has encouraged us to believe that increasingly, there'll be an increasing demand in 2003 for the products and services PC connection provides. Next, Ken will review with you some of the fourth quarter sales and marketing highlights. Then, Mark will report on some additional operating metrics and the state of our balance sheet, as well as update you on our outlook for the balance of 2003. Ken.

Thanks Pat. Good morning everyone. The near term sales and marketing strategies that we set out for you last year are working.

Those strategies were-- to improve the sales productivity for account manager, to realize positive results from our investment in our new website technology. To improve gross margins, the key results from recent investments in our government and education business, and to support the continuing sales success of our recently acquired subsidiary MoreDirect. Excluding MoreDirect, the updated sales productivity improved in the fourth quarter of 2002 to $2.3m compared to $2.1m for the year ago quarter. MoreDirect's sales productivity improved sequentially to $3.9m from $3.8m for the third quarter of 2002. Sales in our SMB segment, PC Connection Sales Corporation, were down sequentially by 3.8%. Subtracting out that $7m in incremental Microsoft sales achieved in Q3 of 2002 from the sale of Microsoft's upgraded [vantage] products, sales in our SMB segment in Q4 were virtually flat with Q3. Sales in our public sector GovConnection were down sequentially by 12.2%. Sales for the Federal Government increased sequentially by 6.3%. Although they were down by 8.5% from last year's unusually strong Q4, that was aided by 9/11 replacement sales. Sales for the state and local government and educational customers declined sequentially by 33.5%, but were up 6.7% over last year's Q4.

MoreDirect sales for the fourth quarter were $69.9m, flat with the third quarter but up 38% on a pro forma basis from the prior year fourth quarter. Investments we made in building a new Internet business account--IBA program, began to produce results from the fourth quarter of 2002.

Excluding MoreDirect, net sales for IBA's grew sequentially over the third quarter of 2002 by 32% and increased over the fourth quarter of last year by 78%. The number of IBA users as of December 31st, 2002 expanded to 35,416 compared to 22,192 as of September 30th 2002.

As Pat mentioned earlier, gross profit margins, both with and without MoreDirect improved to 11.1% in the fourth quarter of 2002 compared to 10.9% for both third quarter of 2002 and the fourth quarter of last year. Gross margins were higher due to improvement in product mix and selling margins. Gross profit margins in our SMB segment for the fourth quarter of 2002 were virtually flat sequentially at 12.32% and up 45 basis points from the year ago quarter. Gross profit margins in our public sector segment GovConnection for the fourth quarter of 2002 were up sequentially by 27 basis points to 8.65% and down 25 basis points from the year ago quarter.

In addition, gross profit margins in our large account segment, MoreDirect, were up sequentially by 32 basis points to 11.1%. Our ongoing efforts to improve product margins continue to emphasize enhancement of add-on sales for accessories and consumables, increasing sales of enterprise class products as a percent of total net sales, increasing account penetration with PC Connection and third party value-added service offerings. A greater focus on solution sales and a greater utilization of vendor rebate programs.

Average order size increased about 7% to a $1,135 in Q4 from a $1061 in Q4 of last year, while decreasing about 14% from $1,323 in Q3 of 2002. Total orders entered, another fundamental operating metric, also increased during Q4 to 300 and 9800, a 4% increase over the fourth quarter of 2001. In the combined sales organizations we ended the fourth quarter with a total of 479 outbound sales account managers compared to 511 account managers at September 30, 2002 and 464 at the end of Q4 of 2001. We continue to steadily recruit new account managers, and expect that the total number of account managers in 2003 will grow as we improve sales productivity. Our goal is to improve the performance and incomes of our existing account managers before we add to their numbers.

On the product side, Q4 results saw sales grow sequentially in desktop servers, printers, memory, and accessories. The growth in printer sales was aided by an $8m HP Laser shipments to a major federal agency. This sale involves several add-ons being configured in the short period of time and shipped to a hundreds of different locations. It is also our understanding that this was the largest printer sale ever completed by HP to a federal agency. After a strong growth in Q3, software and notebook computers declined sequentially in Q4 by 35% and 16% respectively. We recently added the Micron product line to bolster our offerings in the desktop, mobile, and server area with particular emphasis on the desktop space. Micron has a great configuration tool and has been very responsive competitively when we go head-to-head with Dell. In addition, at the end of December, we added Sun Microsystems to our server and workstation line up.

Sun's expansion of their Cobalt series into servers powered by Intel with focused support on the Linux segment that our SMB customer's growing demand for Linux as part of their core infrastructure. We've spent the early weeks of January completing our technical staff certifications and have completed an initial training of our entire sales organization. Sun will be an important ingredient for our continued growth of our Enterprise product mix. In Q4, net sales of Enterprise class products were 23.4% of total net sales compared to 22% in Q3.

As I noted last quarter, the acquisition of MoreDirect has accelerated our mix shift to Enterprise products. Year-over-year net sales of such products grew in Q4 by 22.4%. We continue to devote significant resources for the expansion of our Enterprise class product offerings and believe an additional growth is achievable in this area. We see opportunities with server consolidation and storage utilization. In addition, we see growing demand in niche security products with key vendors such as Cisco and [inaudible] for firewall solutions, McAfee and Symantec for virus protection and intrusion detection, RSA Security for authentication, Computer Associates and Veritas for storage data protection, HP for storage, recovery, and backup, APC for power protection, and several others. And, now Mark will provide you with some further details about our operating metrics and financial position. Mark.

Thanks, Ken. Continuing with the review of our fourth quarter operating metrics, average selling prices or ASPs for computer systems decreased during the quarter by about 4%, compared to fourth quarter of last year, and were down approximately 12%, compared to the third quarter of 2002. The sequential decrease resulted from 11% sequential decrease in notebook ASPs; a 12% decrease in desktop ASPs; and a 3% decrease in server system ASPs. The year-over-year decrease in ASPs resulted from a 9% decrease in desktop system ASPs. Notebook unit and net sales volumes were down sequentially by 9% and 19%, respectively. Desktop revenues declined 3% sequentially on a 10% sequential increase in unit volumes. Server system unit and net sales volumes increased sequentially by 14% and 10%, respectively, excluding MoreDirect, which is acquired in Q2 of 2002, unit and net sales volumes of server systems increased year-over-year by 15% and 30% respectively. SG&A came in for the fourth quarter at 9.7% of net sales, compared to 9.6% in the third quarter of 2002, and 10% in the fourth quarter of 2001, primarily due to changes in sales volumes. Excluding MoreDirect, the actual dollar amount of SG&A increased by 2%, compared to fourth quarter of 2001, but decreased about of 9% compared to Q3 of 2002, as a result of lower sales volumes. Management continues their focus on reducing costs in our core business. All spending plans and programs remain under continuous review.

Now, let's take a look at the balance sheet. Accounts receivable were down to $7m to $135m as of December 31, 2002, compared to Q3 of 2002 due primarily to the sequential decrease in net sales. Day sales outstanding, or DSOs, were 48 days compared to 50 days in Q3, and 51 days in Q4 of last year.

Inventory balances were flat at approximately $52m as of yearend, compared to approximately $53m as of Q3 of 2002, and were down $5m compared to approximately $57m as of December 31, 2001. Net sales of products drop shipped by distributors and other vendors directly to customers accounted for 40% of total net sales in the fourth quarter, compared to 42% of the net sales in the third quarter of 2002. Although, federal government and large commercial account businesses utilize drop shipment heavily to meet customers demand. Inventory turns were 20 compared to 24 in Q3; based on quarter end levels, inventory days were 17 at December 31, 2002 versus 16 as of September 30, 2002. Inventories are in excellent condition both in quantity and in quality. In summary, the balance sheet remains very healthy.

Looking forward, our outlook for the rest of the 2003 remains cautiously optimistic. Our first quarter, historically, is a softer quarter for sales to federal government agencies compared to the third and fourth quarters of prior year. We expect the sales for the federal government to be sequentially down by approximately 50%. Sales- SMB and educational customers are expected to grow sequentially in low single-digits. Sales to larger account segments are expected to decrease sequentially by approximately 10%.

Therefore, for the first quarter of 2003, we presently expect to achieve sales in the range of $290-305m and earnings per share in the range of 4-7 cents per share. We are expecting that gross margin rates for Q1 will be flat with Q4 and operating expense will be down slightly as we forecast lower sales volumes. We continue to work hard to ensure the best possible midterm results consistent with maintaining a strong financial position and investing for the future. Thanks for joining us today and we will now entertain your questions. Operator.

Thank you. The floor is now open for questions. If you have a question or a comment, you may press the number "1" followed by "4" on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the "#" key. Once again, if you have a question or a comment press "1" followed by "4" on your touchtone phone. Your first question is coming from David Manthey of Robert W. Baird.

Hi. Good morning everyone.

Good morning.

Question on the productivity -- I noticed that the tenure of the average account manager has increased. Productivity has also increased-wonder if you can help me with the productivity in each strata, for example? Has the productivity of 1-2 year of raps improved or is the productivity increased due solely to the increase in tenure and then second if you could talk about any changes in training or compensation?

I would say, overall the improvements in the productivity is really due to the improvements in the tenure that you saw. You can see that we -- both in the government units and the SMB units-- tenure did improve by 4-5 days -- 5 months, I mean.

And in terms of the training and compensation, there haven't been radical changes in training during the period but there are changes in focus, increased training on enterprise class products, for example, has been an important part of it. There have been no fundamental changes in the compensation plan.

Okay and then margins, how sustainable is 11%? Can that go to 12% over time? And maybe you can talk about HP's partner one in what you are seeing there on the margin?

I want to take the first part of your question, and I will turn the second part of your Bob on the HP part. 11%, I think is definitely achievable when you look at 2003. Beyond 11%, you are getting up to 11.5-12%, I think it's the stretch at this point and the reason why I say that is -- growing our government businesses and we are also growing our large account business, MoreDirect, and atypically have lower margins. In 2002, we saw improvements on a sequential basis in our SMB segment throughout the year, and I expect to see some of additional improvements in that segment in 2003. But, I think it's going to be offset by lower margin rate in the government and in the MoreDirect segment.

On the HP part of the one program, all that a little bit more difficult to work with and all that more people power applied to it. We are seeing margins that are consistent or even a little bit greater than we saw before the part one program was put in place. And the more significant piece right now is, we finally have seen stabilization with HP and the product line, and we have some very good products in the servers and no growth in desktops but [inaudible] will go very well. We are seeing increased sales across the board in all this product line.

Okay, and just one final question. MoreDirect, could you give us an idea, what percentage of sales that the largest customer has or the largest five customers?

I would say it is probably in the 10-20% range.

For the single largest customers?

Largest five.

The largest five. Okay 10-20%. Okay that's helpful. Thank you very much.

Thank you. Your next question is coming from Brian Alexander of Raymond James.

Thanks, good morning. I had a couple of questions on your comments about gross margins being flat sequentially in the first quarter. If the mix shift is in your favor with respect to gross margins meaning federal and large accounts below its gross margin business is going to be down more than SMB and Education. I am just wondering what you might be implying about gross margins overall, given that, you would think that gross margins could be up sequentially with that mix?

That's a true statement Brian, but one thing you're not factoring in is that, I think the MoreDirect gross margins will come down from the levels that you saw in 2002. So the improvement you would expect from the mix shift in the government unit, I think it's going to be offset by lower gross margin rate in MoreDirect. SMB, I expect to be at similar levels to slight improvement

I guess that leads into my next question on MoreDirect. I think you -- that the gross margins that are little over 11% and if we look at other similar types of corporate resellers, if you will, there are in 8-9% range, so is that where you think we are headed with MoreDirect gross margins or could you help us understand were they-- ?

No, I don't think we are headed there at all. I think we are more headed in somewhere under reasonable level, around 10.5% range in 2003.

Okay. Thank you.

Thank you. And once again if anyone has a question or a comment, that's "1", followed by "4" on your touch-tone phone at this time. Thank you. Your next question is a follow up question coming from Brian Alexander of Raymond James.

It's a quick follow-up on -- it's just overall sales trends right now -- I think the December quarter was a bit strange and that November weekend and December looks like it gave some strength. So, as we fast forward into the current quarter, would you say that we are tracking in line with normal seasonal patterns, maybe like we were a quarter ago, is that a fair statement?

I think it's a fair statement Brian.

Alright. Thank you.

Thank you. Your next question is coming from Chris Hussy of Goldman Sachs.

Good morning gentlemen. Could you just comment a little bit on the government sales and particularly the steep drop in state and local government? Did that surprise you at all? And also the Federal government continuing to grow to debt on a sequential basis--is that surprising to you at all? And what are you guys expecting?

Sure. Q4 last year for Federal was very strong as a result of the 9/11 events. This year Q4 was stronger than Q3. I think what really happens is that Q3 is -- lot of the sales are being booked and so they have built a backlog at the end of Q3 going into Q4. That happened last year, it happened this year. And so it's really just fulfilling those orders that we generated in Q3. Looking at the state local education business, it was a little bit lower than I was anticipating in early in the quarter. But the sequential decrease overall is similar to prior year trends. When you look at that business, the Q2 and Q3 are the strongest quarters and particularly in the education arena.

And so when you guys look ahead to 2003, given the budget constraints that may or may not exist in America, are you concerned at all by that business?

Not at all. I think the growth that we are seeing is really coming from the education part of the business, in the K-12 and the universities is doing very well in that business and I expect to continue to grow on a year over year basis in that business.

Thanks gentlemen.

Thank you. And as your final reminder, if anyone has a question, please press "1", followed by "4" on your touch-tone phone. Thank you, we have another follow up question from David Manthey of Robert W. Baird.

Hi, this is a pretty broad question, but looking at SG&A levels as a percentage of sales today for the size of the Company, if you look back relative to some of your larger competitors, it seems like SG&A levels have been as good as 7-7.5 and as bad as say, 8-8.5. Just wondering, the cost structure of the Company today and that SG&A percentage of sales. Does it seem high to you still today and do you feel if that's an opportunity for you over the next 12 or 18 months, or is the level that we were seeing today above or we should expect based on your infrastructure investments?

The SG&A rate is higher than we'll all like. It's a continued focus every month with management and our board. I can tell you that the way we were going to get that SG&A rate down is from continual cost reductions that we have been working on throughout 2002. We'll continue in 2003, but the biggest way we are going to gain ground on that rate is really with sales productivity. When you compare our sales productivity to our competitors, more particularly to our [CDWs] in Chicago, we are roughly half in each of the tenure bans. And, so if we can increase our sales productivity by 50%, you can do the math and see what it does to your SG&A rate. It's pretty significant. So I would expect SG&A rate should go down in 2003 and in the future. It's not at [accessible] levels at all.

okay. A follow-up to that. Recently insiders indicated that they plan on doing some more national brand and advertising and CDWs indicated in the past -- they feel the part of the reason there reps are more productive is because of that. Any plans that you are thinking in terms of broad brand advertising?

No. We have no such plans. We believe that our opportunities in sales, our productivity are so significant that we can effect it without major outlays for National Advertising.

Alright. Thank you. Good quarter.

Thank you. Your next question is coming from Colin Campbell (ph.) of Brookeside Capital.

Hi. Thanks for taking my question. Just few quick questions. First, just on the comments around account managers. I think I heard you guys say you thought that the number of account managers would increase over 2003, but at the same time you guys were focused on getting increased productivity out of your existing account manager base. So I just wanted to better understand what metrics are you trying to achieve if there are any particular metrics before you actually start to increase hiring on the account manger front? That is my first question.

I don't know that we have a line in the sand and a very specific metric. It is a matter of the trend. We continue to employ the same size HR and training organization so that we can move quickly to add when we see the marketplace and our sales productivity numbers move up.

How does tenure vary by the different business units?

Mark has got the stats but while he fishes for them...

Sure, the other. My next question was --

He has fished --

Okay. Good.

The average tenure in our government unit is 31.7 months and in our PC Connection or SMB unit it was a 25. In overall for those two units it's around 27, when you add them together. And in the MoreDirect unit we really don't track tenure in that unit. They typically hire experienced reps, people with 10-20 years of experience and will bring to MoreDirect an existing account base. So it is not the same type of metrics you would use in SMB and Gov.

Okay. In the press release you talked particular strength I think at the tail end of December, could you just talk about how that has changed if at all going into January, and whether or not there is any particular strength or weakness in any specific product category, desktops, printers, networking, etc?

Hi Colin, our strength in [inaudible] and desktops and notebooks particularly in December, and we believe that is going to continue in through the quarter primarily [surged] on HP and some [priority] initiatives they have taken on their desktops and are competing up with against Dell. Servers were also very strong; we are expecting those to continue also. Network product line that had some note this quarter is Apple. It has taken some pretty good price drops, and new price introductions. We think Apple should be up for the quarter on sales, based on what we are seeing right now.

Okay and what was HP as a percent of product sales?

I would say on average for the quarter it was probably around 30%.

Thanks.

Thank you. We have no further questions at this time.

This is Pat Gallup. Thank you all for your time and interest and have a great day.

Thank you ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.