PC Connection Inc (CNXN) 2003 Q2 法說會逐字稿

Good morning and welcome to the PC Connection second quarter 2003 earnings conference call. (CALLER INSTRUCTIONS ) 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're pleased to have you join us today for PC Connection's 2003 second quarter conference call.

If you have not already seen our press release, you can contact Eileen Gagnon (ph), at 603-423-2322, and she will fax or e-mail you a copy immediately. You may also view it on our website.

Today's call is also being webcast and will be available on PC Connection's website and on streetevents.com.

Before I turn the call over to Pat Gallup, Chairman and CEO of PC Connection, I would 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 the purposes of the Safe Harbor Provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements, as results of various important factors, including those discussed in factors that may affect future results and financial conditions in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, which is on file with the SEC.

In addition, any forward-looking statements represent our views only as of today and should not be relied 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; therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

I will now turn the call over to Pat Gallup, Chairman and CEO of PC Connection.

Thanks, Mark. Good morning and again, thank you all for joining us. Also here with us for the call, in addition to Mark, is Bob Wilkins, Executive Vice President.

We're pleased with the sales growth we achieved in all three operating segments during the second quarter of 2003. Net sales for the three months ended June 30, 2003 increased by 30.4 million, or 10.4 percent, to 321.6 million, from 291.2 million for the quarter ended June 30, 2002. Net income for the quarter ended June 30, 2003 on a Generally Accepted Accounting Principle, GAAP, basis was 1.4 million, or 6 cents per share, compared to .3 million (ph), or 1 cent per share, for the quarter ended June 30, 2002.

Both periods included charges related to workforce reductions and other special charges that reduced earnings and earnings per share. Had these charges not been reported, pro forma net income for the quarter ended June 30, 2003 would have been 1.6 million, or 7 cents per share, compared to .3 million, or 1 cent per share, for the quarter ended June 30, 2002.

Net sales for the small and medium-size business SMB segment increased by 7.5 percent from the second quarter of 2002 to 186.6 million and increased sequentially by 4.4 percent over the immediately preceding quarter. This is the first quarter since the fourth quarter of 2000 that the SMB segment grew over the prior year period.

Sales to government and education customers -- the Company's public segment -- grew for the quarter by 17.8 percent over the second quarter of 2002 to 75 million and increased sequentially by 42.5 percent from the immediately preceding quarter. Sales to the federal government grew sequentially by 40 percent and rose year-over-year by 19.3 percent. Sales to state, local and education customers increased by 16.7 percent from the second quarter of 2002 and increased sequentially by 44.5 percent over the immediately preceding quarter.

Sales to large corporate customers increased by 11.4 percent from the second quarter of 2002 to 60 million and increased sequentially by 40.8 percent over the immediately preceding quarter.

In addition to the improvement in sales growth, other highlights for the quarter of 2003 were improved sales productivity in both our SMB and public sector segments; growth in the number of sales representatives; an increase in the number of active customers; increased sales from our Internet business accounts, or IBA program; and reduced selling, general and administrative expenses as a percentage of sales.

Sales productivity for the SMB segment improved by 11 percent over the second quarter of 2002 to 2.1 million per sales representative. Sales productivity for the public sector segment improved by 14 percent over the second quarter of 2002 to 2.6 million per sales representative.

As we made improvements to sales productivity over the past quarter, we began increasing the number of sales representatives in all of our operating segments. The total number of sales representatives in all of our operating segments increased sequentially this quarter by 8 percent to 546 from 505 as of March 31, 2003. By year-end, we expect to have a total of 555 sales representatives.

In addition, our new GovConnection office, located in Fairfield, Connecticut, was opened in the second quarter of 2003. This office now has a total of 16 representatives and has already begun generating meaningful sales for the Company.

As a result of increased promotional activities, our number of active customers increased by 6 percent over the second quarter of 2002 to 483,000, and increased sequentially by 5 percent over the immediately preceding quarter.

The investments we made in building a new Internet business account, IBA program, continued to produce results in the second quarter of 2003. Excluding MoreDirect -- our large corporate segment -- new sales for IBAs grew sequentially over the first quarter of 2003 by 17 percent and increased over the second quarter of last year by 89 percent. The number of IBA users as of June 30, 2003 expanded to 49,000, compared to 33,000 as of June 30, 2002.

Total SG&A expenses as of a percentage of net sales was 9.3 percent for the second quarter of 2003, compared to 10.5 percent for the first quarter of 2003 and 10.5 percent for the second quarter of 2002. Our improved SG&A rate compared to the above prior periods were due to higher sales volumes in the second quarter and continued profit improvement initiatives.

Gross profit margins decreased to 10.25 percent in the second quarter of 2003, compared to 11.45 percent for the first quarter of 2003 and 10.76 percent for the second quarter of 2002. Gross margins declined sequentially as a result of competitive pressures, free freight promotion for Internet sales and renewed directives to the sales force to increase market share.

Our ongoing efforts to improve product margins continue to emphasize the enhancements of add-on sales for accessories and consumables, increasing sales of enterprise class products as a percentage of total net sales, increasing account penetration with PC Connection and third party value added service offerings, a greater focus on solutions sales and a greater utilization of vendor rebate programs.

On the product (ph) side, we received authorization from Microsoft to sell select and enterprise license agreements (ph). The Company continues to invest in sales and technical resources, focused on enterprise products, and we're now authorized to sell some V484 four way processor servers (ph) and IBM X44 16 wave processor servers (ph). During our first quarter update, we announced a new relationship with Sun Microsystems, and in the second quarter we extended our UNIX product offering through authorization from HP and IBM to sell their UNIX and P Series systems respectively.

In our second quarter, net sales of enterprise class products were 22.2 percent of the total net sales, compared to 23.1 percent in the first quarter. We continue to devote significant resources to the expansion of our enterprise class product offering and believe that additional growth is achievable in this area.

Finally, we remain alert for opportunities in a consolidating market; however, we will only consider acquiring businesses with complementary corporate cultures that add new customers and management talent, and that are immediately accretive to our earnings and key operating ratios.

In summary, during the quarter the Company grew sales and earnings, improved sales productivity in both our SMB and public sector segments, grew the number of sales representatives and increased the number of active customers.

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 the creedo (ph) systems decrease during the quarter by about 15 percent, compared to the second quarter of last year and were down approximately 5 percent compared to the first quarter of 2003. The sequential decrease resulted from a 7 percent sequential decrease in both server and desktop ASPs, and an 80 percent decrease in notebook ASPs. The year-over-year decrease in ASPs resulted from a 1 percent increase in server ASPs, offset by a 16 percent decrease in notebooks and a 26 percent decrease in desktops. Notebook unit and net sales volumes increased sequentially by 32 percent and 22 percent, respectively. Desktop revenues increased by 3 percent sequentially on an 11 percent sequential increase in unit volumes. Service systems unit and net sales volumes increased sequentially by (inaudible) percent and 15 percent respectively. Excluding MoreDirect, which was acquired in Q2 of 2002, unit sales service of systems increased year-over-year by 36 percent and sales volumes increased by 41 percent.

Our improved operating costs are primarily the result of our focus in reducing costs in our core business. All spending plans and programs remain on an continuous review to ensure the best possible deployment of our resources.

Now let's take a look at the balance sheet. Cash flow generated from operations for the first six months of 2003 was 13.6 million, compared to 27.1 million the same period a year ago. The earn out consideration of 5.8 million paid to the stockholder (indiscernible) the first six months of 2002 was funded from cash flow without the use of borrowed funds. Accounts Receivable were down 13 million to 122 million at June 30th, compared to December 31st, due primarily to the improvement in cash collections. Day Sales Outstanding, or DSOs, were 45 days, compared to 51 days in Q1, and 48 days in Q2 of last year. Inventory balances increased approximately 62 million at June 30th, compared to approximately 52 million at December 31st; fifty percent of the increase in inventory was due to in transit in transit inventory. Net sales of product (indiscernible) shipped by distributors and other vendors directed to customers (ph) accounted for 36 percent of total net sales in the second quarter, compared to 34 percent of net sales in the second quarter of last year. Both our federal government and large commercial account businesses utilized drop shipment heavily to meet customer demand. Inventory turns were 20, compared to 19 in Q1, and 22 in the second quarter of 2002. Based on quarter end levels, inventory days were 20 at June 30th, versus 17 at December 31st. 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 third quarter of 2003 remains cautiously optimistic. Sales to SMB customers are expected to grow sequentially in low single digits. Sales to government and education customers are expected to grow sequentially in the mid 20s to low 30s. Sales to large account segments are expected to increase sequentially in the low to mid single digits. Therefore, for the third quarter of 2003 we presently expect to achieve sales in the range of 342 million to 358 million and earnings per share in the range of 9 cents to 12 cents per share. We're expecting a gross margin rate as a percentage of sales for Q3 to be in the range of 10.45 percent to 10.65 percent and operating expenses as a percentage of sales to be in the range of 9 percent to 9.25 percent. We continue to work 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 today. I will now entertain your questions. Operator?

(CALLER INSTRUCTIONS)

Brian Alexander, Raymond James.

This is Peter for Brian. A quick question. Looking at the corporate segment, there is 15 percent sequential revenue growth. How much of that is deferred spending from the first quarter versus normal seasonality or market share gains?

I would say probably around five percent of it was deferred from the first quarter and the rest of it was due to normal seasonality and growth in the business in the second quarter.

You said five percent?

Yes, I would say about five percent of the fifteen percent sequential growth was (multiple speakers) deferments from Q1 into Q2. Very little of the growth was related to deferments from Q1 to Q2.

Thank you.

David Manthey, Robert W. Baird.

This is Michael Connelly for David Manthey. My first question is, what were the operating profitability levels on a segment basis? You've historically given that? Are you going to give that anymore?

We historically give it when we file our 10-Q for the quarter, so at this time we're not giving that information, no.

Anecdotally, were you profitable in your SMB division on an operating profit basis?

I think looking at the consolidated numbers, before MoreDirect, it was about a -- call it a three cent loss for the quarter.

One of your competitors had mentioned that rebate levels at some OEMs were unusually high this past quarter. Did that affect your strategy of lowering gross margin to get market share? If you could maybe comment on what you're seeing rebate levels.

I think rebate levels that we achieved during the quarter, both from special bid dollars (ph) we get from vendors and our volume rebates, were very consistent with what we received in prior periods. As far as the margin rate is concerned, we were much more aggressive this quarter in going after deals that would have been -- that were lower margins than we have typically had taken in the past in order to increase the market share.

And based on your gross profit margin guidance for next quarter, it looks like you may be continuing that strategy?

I would say that, yes, we are still going after growth for market share; however, we believe that the margin rate for the third quarter will move up from (ph) about 20 basis points to 40 basis points.

Finally -- I will get in the queue -- I heard some rumblings that you have received large account resource status with Microsoft. Is that correct?

That is correct.

Have you seen any meaningful sales? How is that program going?

I think it's too early to tell. We have seen a lot of interest from our customers in being able to sell them that product line. I would say at the end of Q3, in our third quarter conference call, we will be able to more specifically speak to how well we're doing in that program. We're just a month and a half into it at this point.

Thank you very much.

Matt Sharon (ph), Thomas Wiesel.

If you could expand a little bit on, or elaborate on, the demand picture -- obviously things were weak in the March quarter and if you could just talk about what you saw from customers? Were projects that were pushed off in the first quarter, getting done in June? What are your customers telling you in terms of spending in general? It looks like things are starting to pick up, so if you could give us some color there.

I would say overall we see demand picking up, but I would say it is still very competitive and that's why the margins are at levels you saw for the quarter. But we saw our demand picking up in the first month of the quarter, so we saw year-over-year growth in April versus April of 2002 -- May of this year versus May of last year. In June the year-over-year growth was greatest in June versus prior year. So we saw a steady increase in demand as the quarter progressed. It's too early to tell whether this is going to continue at the same rates we saw in Q2. We're happy with our growth in Q2, but we want to see a longer period of time with our customers really picking up demand before we claim that we are really seeing a big turn in events here.

And I know you've expanded your account manager base. Are there plans to expand that further?

At the end of the first quarter we said we were going to increase it by 10 percent to 555 by year-end; we're at 546 in account reps as of June 30th. Our goal is still to be at 555; however, if we see continued improvements in sales productivity, as we've seen during the first six months of this year, we could change that going forward. Our goal at this point is still to keep it at 555. Any update to that, we will let you know in the third quarter.

(CALLER INSTRUCTIONS) David Manthey, Robert W. Baird.

Mike Connelly again. One question with the more direct earnout. Is that -- I guess maybe if you could go over what exactly the dynamics of that agreement are; are you accruing for it or is it going to be a onetime expense because it seems like MoreDirect is hitting the cover off the ball here?

Yes, they are. What we do is at the end of the year we accrue for the additional consideration we have to pay to the shareholder of MoreDirect. That additional amount does not hit us as an expense; it ends up being goodwill as an asset on a balance sheet. So basically at the end of the year, we increased debit (ph) goodwill and we credit an accrued liability, and once we finalize the numbers through the audit we pay that out in the end of February to March time frame.

And the dynamics of that is that there was two components of earnout consideration -- there was a cash escrow that we set aside at the time that we did the acquisition of $10 million -- half of that cash escrow has been paid out in March of this year, so there's 5 million more to be paid out if they continue to maintain earnings at a certain level that will be paid out; there is additional contingent consideration that the earn if they continue to hit the levels that are outlined in the agreement and that was at the end of last year we accrued additional 5.8 of earnout consideration. The run rate that they're on at this point for this year, I see as potentially paying out additional earnout consideration above and beyond the additional 5 million -- around 6 to $7 million in March of 2004 -- or 2003 -- leaving one year left on the earnout. The earnout goes through the end of 2004.

So it's a cash only? It doesn't hit the P&L?

The P&L -- it is increasing the -- it's a transaction on a balance sheet increasing goodwill.

So that's not a --

There's nothing that runs through the P&L.

Right. Thank you very much.

(CALLER INSTRUCTIONS)

Sir, I'm showing no further questions at this point.

This is Pat Gallup. Thank you all for joining us and have a great day.

Thank you for joining today's PC Connection conference call. Please disconnect your lines and have a wonderful day.

(CONFERENCE CALL CONCLUDED)