PC Connection Inc (CNXN) 2003 Q1 法說會逐字稿

Good morning ladies and gentlemen. And welcome to the PC Connection First Quarter 2003 Earnings Conference Call. At this time all participants have been placed in a listen only mode. And the floor will be open for questions following the presentation. I would now like to turn the floor over to your host, Mr. Mark Gavin, Chief Financial Officer of PC Connection. Sir, the floor is yours

Thank you and good morning everyone. We’re pleased to have you join us today for PC Connection’s 2003 First Quarter Conference Call. If you haven’t already seen our press release, you can contact [Eileen Gagnon] at (603) 423-2322, and she will fax or email a copy to you immediately. You can also view it on our Web site. Today’s call is also being Web cast. And that will be available on the PC Connection Web site and on StreetEvents.com.

Before I turn the call over to Pat Gallup, President and Chief Executive Officer of PC Connection, I’d like to inform our participants that 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 we 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 as factors that may affect future results and financial conditions in the company’s annual report on Form 10K for the year ended December 31, 2002, which is on file with the SEC.

In addition, any forward-looking statements representing our views only as of today, and should not be replied upon as representing our views as of any subsequent date. While we may elect to update our forward-looking statements at some time in the future, we specifically disclaim any obligation to do so, even if our estimates change. And therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

During this call we will not be referring to any financial information not prepared in accords with general accepted accounting principles, or non-GAAP financial information. In light of new Regulation G, we respectfully decline to answer any questions seeking non-GAAP financial measures. I’ll now turn the call over to Pat Gallup, President and CEO of PC Connection. Pat?

Good morning. And again, thank you for joining us. Also here with us for the call is Bob Wilkins, Executive Vice-President. I’ll start by saying we’re pleased with the progress we made in Q1 to improve our overall financial performance. Net sales for the three months ended March 31, 2003 increased by $46.4m, or 20%, to $283.5m from $237.1m for the three months ended March 31, 2002.

Net income for the quarter was $1.6m or $0.06 per share, compared to a net loss of $2.1m or $0.09 per share for the three months ended March 31, 2002. Net sales for our small and medium-sized business, SMB segment of $176.6m declined by 4.8% from the first quarter of 2002, but increased sequentially by 6.5% over the prior year’s fourth quarter. We’re encouraged with the sequential improvement in net sales for this segment.

Sales to government and education customers, our public sector, grew for the quarter by 6.4% over the first quarter of 2002 to $52.6m, but were sequentially down by 37.7% from the fourth quarter of that year. The sequential decline in net sales this quarter was consistent with the historical seasonality in our Federal government sales. But sales were lower than we anticipated. The delay in passing the Federal Budget appears to have impacted our Federal sales for the first quarter. However, we continue to believe that our Federal business will have another good year in 2003.

Sales to state, local and education customers grew sequentially this year by 1.3%, and year over year by 17.2%. Sales to large account customers declined sequentially in the quarter by 25.3% to $52.3m. Sales to large account customers had a slower start to the year than we anticipated. We believe that large customers have delayed purchasing information technology equipment due to uncertainties surrounding the situation in Iraq. Although MoreDirect sales were lower than we had anticipated, their operating margins for the quarter were strong. MoreDirect operating margins were up sequentially by 77 basis points to 6.6%.

We believe that the key objectives that we set out for last year are working. Those strategies were to improve the sales productivity for sales representatives, realize positive results from the investment in our new Web site technology, achieve results from recent investments in our government and education business, support the continuing sales success of our recently acquired subsidiary, MoreDirect, improve gross margins, reduce our operating costs, invest for future growth and prosperity and, finally, remain alert for additional market consolidation opportunities.

Sales productivity for the SMB segment improved sequentially this quarter by 10%, to $2.2m per sales representative, and also improved 14.7% over the first quarter of 2002. Sales productivity for the public sector improved 24.3% over the first quarter of 2002. We believe generating higher sales productivity is the key to leveraging our expense structure, and driving future profitability improvements.

Now that we’ve seen improvement in sales productivity this past year, we will begin increasing the number of sales representatives in all of our operating segments. By year end we expect to increase our number of sales reps by 10% to approximately 555 from the 505 we had as of March 31, 2003. In addition, in Q2 we expect to open a GovConnection office in Fairfield County, Connecticut.

The investments we made in building a new Internet business account IBA program continues to product results in the first quarter of 2003. Excluding MoreDirect, net sales for IBA grew sequentially over the fourth quarter of 2002 by 10%, and increased over the first quarter of last year by 81%. The number of IBA users as of March 31, 2003 expanded to 41,298, compared to 32,138 as of March 31, 2002.

On the products side, we recently added Sun Microsystems to our server, storage and workstation line-up. And we completed the sales and technical training requirements at the beginning of the quarter. This authorization is consistent with our strategy of expanding our enterprise class product focus, and extends our reach into the UNIX marketplace.

The company also recently enhanced its ability to provide a broader range of enterprise storage solutions, by adding IBM’s Total Storage products and the Data Storage Switch products. We see opportunities in server consolidation, storage area network, and a continued focus on security products. We also believe the introduction of a new server operating system from Microsoft, announced earlier, will help generate a new upgrade cycle, particularly for customers presently standardized on older server operating systems, such as NT 4.0.

In Q1, net sales of enterprise class products were 23.1% of total net sales, compared to 23.4% in Q4. As we 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 Q1 by 31.2%. We continue to devote significant resources to the expansion of our enterprise class product offerings, and believe that additional growth is achievable in this area.

Our gross profit margin as a percentage of net sales was 11.5% in the first quarter of 2003, compared to 11.1% in the fourth quarter of 2002, and 10.5% in the first quarter of 2002. This represents a 93 basis point year over year improvement. Gross margins were higher, due to an improvement in product mix and selling margins.

Gross profit margins in our SMB segment for the first quarter of 2003 were down sequentially to 11.8% from 12.3% in the fourth quarter of 2002, but increased 85 basis points from the first quarter of 2002. Gross profit margins in our public sector segment, GovConnection, for the first quarter of 2003 were up sequentially by 80 basis points to 9.5%, and up 51 basis points from the year ago quarter.

In addition, gross profit margins in our large account segment, MoreDirect, were up sequentially by 120 basis points to 12.3%. Our ongoing efforts to improve product margins continued 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 18% to $1,058 in Q1 from $894 in Q1 of last year, while decreasing about 7% from $1,135 in Q4 of 2002. Total orders entered – another fundamental operating metric for PC Connection – also increased during Q1 to 324,000, a 3% increase over the first quarter of 2002, and a 5% increase over Q4 of 2002.

Total SG&A expenses as a percentage of net sales was 10.5% for the first quarter of 2003, compared to 9.7% for the fourth quarter of 2002, and 11.6% for the first quarter of 2002. Our improved operating costs compared to the same period in 2002 are primarily the result of lower bad debt expense, restructuring costs, and consulting costs. In addition, we continued to adjust staffing and spending levels in all areas of operations.

Finally, we remain alert for opportunities in a consolidating market. But we will only consider acquiring businesses with complimentary 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 organization. Next, 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. Mark?

Thanks Pat. Average selling prices, or ASPs, for computer systems increased during the quarter by about 1% compared to the first quarter of last year, and were down approximately 1% compared to the fourth quarter of 2002. A sequential decrease resulted from a 2% sequential decrease of our notebook and desktop ASPs and an 8% decrease in server system ASPs.

The year over year increase in ASPs resulted from a 4% increase in server ASPs, offset by a 2% decrease in notebooks, and a 5% decrease in desktops. Notebook and net sales volumes increased sequentially by 10% and 9%, respectively. Desktop revenues declined 15% sequentially on a 13% sequential decrease in unit volumes. Server systems unit and net sales volumes decreased sequentially by 16% and 23%, respectively.

Excluding MoreDirect, which was acquired in Q2 2002, unit sales of server systems increased year over year by 11%. But sales volumes decreased by 6%. Our improved operating costs are primarily the result of our focus on reducing costs in our core business. All spending programs continue to be under review, and to ensure the nearest term possible best deployment of our resources.

Now let’s turn over to the balance sheet. Cash flow generated from operations during the first quarter of 2003 was $11.1m, compared to $8.8m for the same period a year ago. The [earn-out] [ph] consideration of $5.8m paid to the stockholder of MoreDirect during the first quarter was funded from cash flow, without the use of borrowed funds.

Accounts receivable were down $13m to $122m at March 31, compared to December 31, due primarily to the sequential decrease in net sales. Day sales outstanding or DSOs were 51 days, compared to 48 days in Q4, and 52 days in Q1 of last year. Inventory balances increased to approximately $57m at March 31, compared to approximately $52m at December 31. The increased inventory was primarily due to in-transit inventory.

Net sales of products drop shipped by distributors and other vendors directly to customers accounted for 41% of total net sales in the first quarter, compared to 40% of net sales in the fourth quarter of 2002. Both our Federal Government and large commercial account businesses utilize drop shipment heavily to meet customer demand.

Inventory turns were 19 compared to 20 in Q4, based on quarter-end levels. Inventory days were 21 at March 31, 2003, versus 17 at December 31, 2002. We believe 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 second quarter of 2003 remains cautiously optimistic. Sales to SMB customers are expected to grow sequentially between one and five percent. Sales to government and education customers are expected to grow sequentially between 5% and 20%. Sales to large account segments are expected to increase sequentially between 5% to 15%.

Therefore, for the second quarter of 2003, we presently expect to achieve sales in the range of $290m to $310m, and earnings per share in the range of $0.05 to $0.08 per share. We are expecting the gross margin rate as a percentage of sales for Q2 will be in the range of 11.2% to 11.3%, and operating expenses as a percentage of sales to be in the range of 10% to 10.3%.

We continue to work hard to ensure the best possible near-term results, consistent with maintaining a strong financial condition, and investing for the future. Thank you for joining us today. We will now entertain your questions. Operator?

Thank you. The floor is now open for questions. (Caller Instructions.) Your first question is coming from [Ethan Jewel] of PC Connection in Dover, New Hampshire. Please state your question.

It must be a mistake Operator. I have no question.

Your next question is coming from Brian Alexander of Raymond James. Sir?

Good afternoon. Just a couple of questions here. On your revenue guidance for MoreDirect, I think you said up 5% to 15% sequentially Mark. Last year I think you were up six. So I’m just trying to understand the optimism going forward for the June quarter on that business. And then on overall operating income, I think you said operating margins for MoreDirect were about 6.6%. I guess that would imply that the other segments had operating losses. I just wanted to verify that. And if that’s the case, when do you expect the other segments to return to profitability? Thanks.

Let me take your second question first Brian. As you heard in my earlier remarks, I can’t talk about non-GAAP measurements. So if I talk to you about a number other than what the consolidated number looks like, I would be violating that statement. So I really can’t comment on that. But MoreDirect’s operating margins were 6.6%. So you can do the math yourself.

As far as your first question was, is why we’re so optimistic with regards to MoreDirect, we have a lot of visibility into projects that MoreDirect’s salespeople are working on. And we believe that a lot of those projects were delayed in Q1 as a result of the conflict in Iraq. And therefore the visibility in Q2 is better. And that’s what kind of gives us the optimism that we’re going to have a greater percentage growth in Q2 versus last year.

Okay. And then just one quick follow-up on productivity. You had some big increases, both sequentially and year over year. Can you just help us understand the impact from tenure maturity increasing versus actual productivity improvements by tenure? If there’s any numbers you can put on that, that would be helpful.

Brian, I don’t have those numbers in front of me. But I’ll speak in general terms to you on that. I think it’s a combination of both. The tenure is moving up on a year-over-year basis. It probably moved up probably six to nine months on a year-over-year basis for average tenure. And the productivity within the tenure – in the different tenure bands are also improving.

Great. And then just one final, I guess, accounting question. One of your competitors, CDW, had a reclassification of co-op from SG&A up to gross profit. I didn’t see anything in the press release or hear anything about that. So I assume that you don’t have any such re-class.

Your assumption is correct Brian.

Thanks.

Thank you. Your next question is coming from David Manthey of Robert W. Baird. Please state your question.

Hi. Good morning. Along the lines of the last question there by Brian, this EITF 216, you say you’re in compliance with that. What I’m wondering about is when you looked at the gross margin in SMB, it was running at 12.3. And this quarter it was 11.8. I’m wondering why that was. And then conversely, if you look at the GovConnection and MoreDirect, the gross profit there was significantly better than it had been running. Is there any light you can shed on that as far as the changes there?

For SMB the gross margin did come down slightly. And that was more the result of – I think there were some lower margin deals in the notebook area that we were able to have in Q1 that had positive gross profit dollars and contribution to the company’s bottom line compared to previous quarter. That’s really the difference in SMB.

And when you talked about the strength in Gov and MoreDirect, Gov sales were down. And therefore, some of the larger deals that you had in previous quarter for Gov were not present in Q1, and therefore produced a higher gross margin. And in MoreDirect, their sales being down also. Some of the larger, lower margin deals that they had in previous periods were not present during Q1. So it was more some of the larger deals disappearing in those two segments.

Okay. So along with your slightly more optimistic revenue guidance for the second quarter, we should also assume that within those segments, margins would be more normal?

That the – yes. The margins guidance that I gave was in the 11.2% to 11.3% range. And the reason why it’s down is that I expect MoreDirect sales to increase. And I also expect Gov sales to increase, with some larger deals there, and therefore driving the overall margins down. I suspect SMB margins to behave similar to what they behaved in Q1.

Got it. Okay. And on the sales increase sequentially at SMB, the increase was surprising. And how much of that would you say is attributed to these lower margin notebook deals? And how much of that is underlying strength?

I would say it’s probably – the majority of it is due to overall productivity improvements per sales rep is really what’s driving the increase.

Okay. Could you help us with MoreDirect? Your – what have the hiring trends been like there? And I’m just wondering in terms of the year-to-year change in MoreDirect sales. Is that a function of increasing number of salespeople, or just the business? And then also, if you could help us with a pro forma number for the first quarter, what MoreDirect’s revenues would have been – of ’02?

Of ’02, sure. When you talk about – the first part of your question was - ? Could you repeat the first part David?

I’m just wondering what the hiring trends have been like at MoreDirect specifically, saying that if the year-to-year change there, how much of that is attributable to increases in the number of salespeople as we went through the last year, or how much of it is just the underlying business?

With salespeople, I think their overall salespeople numbers were quite comparable in Q1 versus prior year periods. So I really don’t – I’d say it’s more productivity that they’re generating for their sales reps that’s potentially driving their increases in 2003.

They have done some recent hiring. So I expect that their head count in Q2 will end up at a higher level in Q2 versus Q1.

Okay. And do you have that number for the sales in the first quarter?

Sales in the first quarter of last year was around $52m.

Okay. Thank you.

You’re welcome.

Thank you. Your next question is coming from Chris Hussey of Goldman Sachs. Please state your question.

Hey Mark, Chris Hussey with Goldman. A couple questions. Can you give us any thought on how April is going so far? Are you seeing the type of growth that you guys have outlined in your guidance here so far? And is that making you more enthusiastic, just because of what we’ve seen here in the first three weeks plus? And I’ll get back on my second one.

Sure. I would say with MoreDirect and with GovConnection, I would say that it’s meeting our expectations for growth in Q1, and consistent with our guidance. I would say that SMB in recent days is beginning to show more strength then we originally expected. So a little bit more strength in SMB right now, by maybe 1% to 2% higher than what we would have expected at this time.

What do you – do you guys have any thoughts? What would you attribute that to?

We’re seeing that pretty much across the board some budgets freeing up, and just additional quoting activity, and just additional productivity in our salespeople. So it’s across the board. I wouldn’t say it’s any particular large deal. It’s pretty much in all of our sales sites.

You’re looking to grow your sales force by 10%.

Yes.

You’re not alone. But are you guys off to the races here? I mean are you guys just expecting this market to take off?

We have already – our numbers are already up in Q2 from where you saw them at the end of Q1. As Pat mentioned, that we’re planning on opening up a new office in Connecticut. And we’ve already hired people for that office. We’re probably up to 20 additional people for that office at this point. And they will be present some time in May in that office. So we’re already well off to the races with increasing our head count.

I guess I’m asking what’s the thought process behind it? I mean why be so aggressive on head count growth here…

Sure.

… with the IT spending environment the way it is?

Well if you noticed our head count over the past year to two years has gone down quite significantly. And the reason for that is that we’ve been trying to work on sales productivity. And we have said in the past that once we saw an increase in sales productivity we were going to begin adding head count.

As you saw from the first quarter, our sales productivity showed some nice improvement. And therefore we believe it’s a good time to begin adding to head count in all of our segments. We think that with the potential conflict in Iraq, the uncertainty surrounding that potentially being behind us at this time, I think clears the way for people starting to free up some of their spending.

And can you give us a little bit of color about what type of people you’re looking to hire here?

Sure. I would say we’re still looking at hiring experienced people, like we have in the past. But what we haven’t emphasized in recent quarters is starting to hire out of colleges. I think that when you look at the college – people coming out of college today – the market for them getting jobs is more difficult.

Some of our most successful people here at PC Connection came right out of college. And so we think it’s a good time to begin recruiting in the college level again. And that’s really the change that’s taken place, what we’re saying now, compared to what we were saying a few quarters ago.

Yes. And this is Pat. Just to add to that, I think one of the things we’ve been saying over the last couple of calls is that we’re really developing and refining our sales training programs. And we’re really seeing that now starting to pay off. And it’s also helped us zero in on really what the qualities are that we will be looking for in new sales reps to determine success. So it’s all part of our efforts to improve our sales training process and programs.

One last question on EITF co-op ad thing, are you not adopting it because you don’t have to, because you don’t have any such advertising that would apply to it, or because you had an option?

No. We’ve – if you looked at the 10K, we adopted it in Q1 of this year, as we were required to. However, the accounting that we had prior to the adoptions was consistent with adopting the EITF. We were already reclassifying a portion of our co-op dollars up to gross margin for several years now. And so therefore we didn’t have any change, like we saw with one of our competitors reclassifying a large amount out of SG&A out to gross margin. We didn’t have to do that. We’ve been doing that for a number of years.

Terrific. Very impressive Mark. Thanks a lot guys.

Thank you.

Thank you. (Caller instructions.) Your next question is a follow-up question from Brian Alexander of Raymond James. Please state your question.

Your growth in your state and local business in education – very impressive year-over- year 17. And then sequentially you were able to grow. There’s been a lot of talk about budget deficits in state and local governments. And so I’m kind of surprised at the year-over-year growth there. What’s your sense that what that addressable market is doing versus perhaps what your share gains look like – and are you seeing that segment overall getting more difficult? Or is it pretty stable?

For some time Brian that overall segment has been – has had a difficult time from kind of a macro point of view out there, with some of the deficits that states are seeing. Our growth that we saw last year, and we continue to see, has been the K-12, and also through Higher Ed. And we expect to continue to see growth in those areas in 2003.

When you look at our overall market share that we have, we have a tiny bit of the overall market share. So our growth is not really coming from an improving marketplace. It’s more coming from share shift coming to GovConnection.

And Mark, can you just remind us approximately the size of your state and local business versus your education business?

Our state and local percentage of sales is – Brian, I don’t have that number right in front of me right now. I’d be guessing. And I don’t want to guess.

Okay. Great. Thanks a lot.

Mr. Gavin, there appear to be no further questions at this time.

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

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