PC Connection Inc (CNXN) 2004 Q3 法說會逐字稿

Good morning and welcome to the PC Connection third quarter 2004 earnings conference call. At this time all parties have been placed in a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Steve Baldridge.

Thank you and good morning, everyone. This is Steve Baldridge, VP of Finance and Corporate Controller. I'm pleased to have you join us today for PC Connection's 2004 third quarter conference call. If you haven't already seen our press release, you can contact Eileen Gagdon [ph] at (603)683-2322 and she will fax or e-mail a copy to you immediately. You can also view it on our website. Today's call is also being webcast. It will available from PC Connection's website and at streetevents.com.

Before I turn it the call over to Patricia Gallup, Chairman and CEO 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 make about the Company's future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in factors that may affect future results and financial conditions in the Company's quarterly report on Form 10-Q for the quarter ended June 30, 2004, which is on file with the Securities and Exchange Commission. In addition, any forward-looking statements represent our views only as of today, and cannot be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements at some point 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. I'll now turn the call over to Pat.

Good morning and, again, thank you for joining us. Also with us today on the call are Bob Wilkins, Executive Vice President and Jack Ferguson, who in light of Mark Gavin's resignation is with us as interim CFO.

As reported in our press release, net sales for the 3 months ended September 30, 2004, increased by $1.9 million or 5% to $351.3 million from 349.4 for the quarter ended September 30, 2003. Net income for the quarter ended September 30, 2004, on a Generally Accepted Accounting Principle, GAAP basis with 2.8 million or 11 cents per share, compared to 2.2 million or 9 cents per share for the quarter ended September 30, 2003. The 3-month period ended September 30, 2004, included special charges related primarily to the GSA contract cancellation reported previously. Had these changes not been incurred, pro forma net income for the quarter ended September 30, 2004, would have been $3.9 million or 16 cents per share compared to 2.2 million or 9 cents for the quarter ended September 30, 2003. That is a 78% increase. Our press release includes a reconciliation of these amounts.

Our initiatives to improve gross profit margins were the key drivers behind our improvement in earnings. Our overall gross profit dollars increased over the third quarter of 2003 by $3.5 million. A $1.9 million increase in sales. Increasing gross profit margins by 94 basis points to 11.22%. This gross profit margin increase included a 23 basis point improvement as a result a reclassification in the third quarter that we will describe in more detail later. Net sales for our small and medium size businesses, SMB segment, increased by 9.1% from the third quarter of 2003 to $195.9 million.

Sales to government and education customers, our public sector segment, increased sequentially by 22.9% over the immediately preceding quarter, but declined year-over-year by 24.8% to $77.9 million. More specifically, sales to the Federal Government increased sequentially by 65.7%, but can decreased year-over-year by 64.8%, reflecting the lost of the General Services Administration contract, again reported previously.

We did receive a new GSA schedule in mid-August 2004, but it was too late to participate fully in the Federal Government's seasonally strong third quarter. Although we expect to see continual improvement, we believe it will take us at least a year to rebuild our Federal Government business. However, sales to state, local and education customers increased sequentially this quarter by 13.9% and increased year-over-year by 15.1%. Furthermore, sales to large corporate account customers, our large account segment, decreased sequentially by 0.6% to $77.5 million, but increased 16.9% from the corresponding period a year ago.

The total number of sales representatives decreased year-over-year from 580 at September 30, 2003, to 571 as of September 30, 2004. On a consolidated basis, annualized sales productivity for this quarter increased 4.6% sequentially and 2.1% year-over-year. Sales productivity in our SMB segment increased 8.2% from the third quarter of 2003, but decreased 1.6% from the second quarter of 2004. Sales productivity in our public sector segment decreased 20.1% from the third quarter of 2003, but increased 30% over the second quarter of 2004. The year-over-year public sector decrease was attributable to decreased federal sales again, resulting from the loss of the GSA contract, together with our continuing decision to retain sales personnel in anticipation of receiving our new contract.

Offsetting these decreases, however, sales productivity in our large account segment increased by 3.5% over the second quarter of 2004 and by 26.5% over the third quarter of 2003. Gross profit margins increased this quarter to 11.2% from 10.8% in the second quarter of 2004, and 10.3% for the third quarter of 2003. Part of this increase was due to our reclassification this quarter of an additional $1.2 million in vendor consideration from SG&A expenses to cost of goods sold and inventory. This reset classification was based on a revision of our estimates of advertising costs and reimbursements related to EITS issue number 02-16. Such vendor consideration had previously been recorded as an offset to SG&A expenses, and this reclassification increased gross margin by 23 basis points and increased SG&A expenses as a percent of sales by 33 basis points for the quarter. Gross profit dollars increased year-over-year in the third quarter by $3.5 million.

We are successfully changing the sales culture. They are now focusing on generating more gross profit dollars per transaction. The largest contributor to our improvement in consolidated gross profit dollars and gross profit margins was our SMB segment. Year-over-year this segment increased gross profit dollars by 3.7 million and gross profit margins by 95 basis points. Our gross profit margins for our public sector improved the by 183 basis points over the third quarter of 2003. While lower federal sales in the third quarter of 2004 contributed to higher margins for the public sector, the majority of the improvement in gross profit margin was due to our initiatives launch in the first quarter of 2004.

Our ongoing efforts to improve product margins continue to focus on increasing add-on sales of accessories and other companion products to our system sales, as well as, increasing the level of enterprise product sales and sales of third-party warranty installation and other services. We also implemented a number of sales and gross profit improvement initiatives, including tighter management of discounting, more extensive and focused sales training on costs and margins, targeted improvements in sales pricing, sale incentives and account management and better communication and administration of vendor rebate programs.

Total SG&A expenses as a percentage of sales were held at 9.3% for the third quarter of 2004, compared to 9.4% for the second quarter of 2004, and 9.2% for the third quarter of 2003, even with the reclassification described above, that added 33 basis points to SG&A this quarter. SG&A rates for the current quarter held steady with prior periods. Income from operations before special charges increased by $2.8 million over the third quarter of 2003. Operating margins improved year-over-year by 78 basis points to 1.89%.

As we have commented in past conference calls, we remain alert for opportunities in a consolidating market. However, we will only consider acquiring businesses with complimentary corporate cultures to add new customers and management talent, and that are immediately accretive to our earnings and key operating ratios.

On August 18, 2004, we announced our that GovConnection subsidiary had been awarded authorization to sell U.S. Federal Government agencies under a new GSA schedule. The GSA schedule, a key Federal Government procurement vehicle enabled GovConnection to more efficiently market products and services to a wide variety of U.S. Government agencies. With our new GSA schedule and recently improved systems, our account managers and support staff at GovConnection are better equipped to meet the specialized needs of Federal Government customers. We strongly believe that GovConnection is better prepared than ever to serve the complex and changing IT needs of our Federal Government customers.

In summary, during the quarter the Company grew earnings by 22.2% with only a 0.5% increase in sales. Given our margin enhancement, initiatives and continuing investment in our sales organizations, along with our GSA schedule, we believe PC Connection has the strategies and resources necessary to enhance long-term shareholder value. I'd like to ask to Bob Wilkins to make some additional comments on our margin improvement initiatives, as well as comment on some marketing trends.

Thanks, Pat. During the last 2 conference calls we spoke about our initiatives to increase our gross profit dollars per transaction in our overall gross margin rate. I continue to be very pleased with the progress we are making with the initiative. As Pat mentioned, our gross margins improved by 94 basis points over last year and by 44 basis points over the second quarter this year. More importantly, our gross profit dollars grew over last year by 3.5 million or 9.7% and grew sequentially by 3.2 million or 9%. Our focus on increasing our gross profit dollars per transaction will carry on into the future. We are optimistic that we will continue to improve our overall gross margin rate.

Average selling prices, or ASPs for computer systems decreased during the quarter by about 1% compared to third quarter of last year. But increased 4% compared to the second quarter of 2004. This sequential increase resulted from a 2.8% increase in server ASPs, and a 2.2% increase in notebook ASPs, partially offset by a 1.1% decrease in desktop ASPs. The year-over-year decrease in ASPs resulted from a 20.9% decrease in server ASPs, a 4.7% decrease in desktop ASPs and offset by a 5.6% increase in notebook ASPs. Notebook unit and net sales dollars increased 3.3% and 9.1% respectively compared to third quarter of 2003.

Desktop revenues increased 1.7% year-over-year on a 6.8% increase in unit volumes. Revenues from server sales decreased 10.3%, while unit volumes increased 13.3% as compared to the third quarter of 2003. The average order size in the third quarter increased year-over-year by 2.9% to 1,341 and increased sequentially by 1.7%. Our stabilized operating costs are a primary result of our focus on continuing to manage costs in our business. We continue to review all spending plans and programs to ensure the best possible deployment of our resources. While we plan to continue our focus on controlling discretionary expenditures, we expect our SG&A expense may vary depending on changes in sales volumes, as well as the levels of continued investment and key growth initiatives, such as hiring more experienced sales account managers, improving marketing programs and deploying next generation Internet web technologies to support our sales organization. And now Steve Baldridge will discuss our balance sheet and cash flow in more detail. Steve?

Cash flow generated from operations for the first 9 months of 2004 was $18.5 million compared to 15.3 million in the same period a year ago. Accounts receivable were down $20.8 million, to 123.5 million on September 30, 2004, compared to the December 31, 2003 balance due to lower receivables from Federal Government customers and the decrease in day sales outstanding or DSOs. DSOs were 41 days compared to 41 days in Q2 and 48 days in Q3 of last year.

Inventory balances were down 2.7 million or 77.4 million at September 30, 2004, compared to 80.1 million as of December 31, 2003. Inventory turns this quarter were 16 compared to 16 in Q2 of 2004 and 19 in the third quarter of 2003. Based on quarterly levels, inventory days were 23 at September 30, 2004, versus 21 at September 30, 2003. We believe inventories are in excellent condition, both in quantity and in quality. In summary, the balance sheet remains very healthy.

Net sales of products drop shipped by distributors and other vendors directly to the customers accounted for 39% of total net sales in the third quarter compared to 39% of total net sales in the third quarter of last year, and 41% of total net sales for the second quarter of 2004. Both our Federal Government and large commercial account businesses primarily use drop shipping to meet their demand.

Looking forward, our outlook for the fourth quarter of 2004 is as follows. Sales to SMB customers are expected to grow year-over-year in the low single digits. Sales to government and education customers are expected to decline year-over-year in the low 20s to low 30s. Sales to large account segments are expected to increase year-over-year in the mid to high single digits. Therefore, for the fourth quarter of 2004, we presently expect to achieve sales in the range of 335 million to 350 million and earnings per share in the range of 11 cents to 14 cents per share. We presently expect the gross margin rate as a percent of sales for Q4 to be in the range of 10.8% to 11%. And operating expense as a percent of sales to be in the range of 9.2% to 9.4%.

We continue to work 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. We will now entertain your questions. Operator?

Thank you. The floor is open for questions. If you have a question, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question, you pick up your handset to ensure proper sound quality. Please hold as we poll for questions. Our first question is coming from Brian Alexander of Raymond James.

Good morning. Just wanted to ask a question about the CFO resignation. Could you give us a little more information on the nature of the resignation. And I guess how can the investment community be comfortable that there is no accounting irregularities or any other irregularities associated with his departure?

Hi, Brian, this is Pat. I don't think it's appropriate to talk about personnel matters in the call. I think I do want to stress in regard to your question that with Mark's resignation, we do have an excellent and experienced team in place to take over and provide the continuity that we think will be needed. Jack Ferguson and Steve Baldridge are 2 people who have been with us for a long time. They have a lot of experience. And I think they are well suited to step in and provide a smooth transition. They also know the Company well, they know the industry well and I think that we will be able to move forward in a really positive way. In regard to any other issues, we currently are not aware of any other issues from a regulatory standpoint other than those that we have previously reported.

Okay. And then just moving on to your guidance, it looks like you're expecting gross margins to be down sequentially. You just talked a lot about some initiatives that seem to be helping over the last couple of years. And I think when we look at your business mix in the fourth quarter, I think if you do the math sequentially, your expecting the most growth sequentially out of our highest margin segment, being SMB, so why would the gross margins be coming down sequentially?

Hi, Brian, this is Bob. We are expecting low growth out of the SMB segment, but that also has some consumers sales that pop into it for Q4. And consumer sales typically have had a little bit lower gross margin with those. We are trying to shed those off, frankly, and move out of that business a little bit, and so we're hoping most of the sales will come out of the business unit, but based on our modeling right now, that's what we're expecting.

Okay. With respect to just overall demand trends, if you could provide a little bit more color on SMB versus corporate. Did you see any change in the tone of business as you moved throughout the third quarter and into October? One of your competitors I think alluded to some slight softening throughout September. I'm just wondering did you see that as well? How would you characterize it?

This is Steve Baldridge. In Q3, Brian, September was our strongest month in the quarter. Historically, August has been the weakest month of the quarter. We had a very strong September and for the first 3 weeks of October, I would say the sales are in line with our expectations and the guidance we're providing for Q4.

I'll continue on that. Talking with the sales directors from the sites, we feel the SMB market is pretty active right now. We feel like the quoting is right in line with what we expect. We don't feel a softness is there. And it's across the board from a product mix throughout all of our categories. So right now we feel comfortable with where we're heading.

Final question. If I do the math on your revenue guidance for large corporate customers, if I use a 10% year-over-year growth rate, which I think is at the high end of what you're expecting, that would imply sequentially your revenue would be down in that segment. I'm just wondering why would that be if large customers are more prone to spend more in the fourth quarter than any other quarter during the year? Is there any change in behavior in that segment or is it a share shift issue? What would you describe that as?

One of the things we have going from last year, we had a large account with more to write [ph] that's no longer with us. And so they've done a good job of peaking that business up throughout the year. So we're just being conservative in our estimates. We'll continue to do sales with more direct [ph].

Thank you very much.

Once again, if you would like to ask a question, please press star 1 on you touchtone phones at this time. Again, that's star 1 for any questions at this time. Gentlemen, there appear to be no further questions at this time.

Thank you all for your time. Have a wonderful day.

Thank you, this does conclude this morning's teleconference. You may disconnect your lines and enjoy your day.